How Does Mortgage Insurance Work?
Most homeowners have wondered how does mortgage insurance work. Unlike other insurance you buy, mortgage insurance does not protect you, the homeowner, against loss; mortgage insurance protects the mortgage issuer against loss should you default on your mortgage. If you do default, the lender sells the property to liquidate the debt and is then reimbursed by the private mortgage insurance company for any remaining amount up to the policy value.
Much like property taxes and homeowner’s insurance, private mortgage insurance is considered a cost of home ownership for many. Private mortgage insurance is lumped into your monthly mortgage payment, so no separate checks have to be written.
Realize that not everyone has to pay private mortgage insurance. Typically, private mortgage insurance is only required if you put down less that a 20% down payment on your home. That is to say, mortgage insurance is only required if the loan-to-value (LTV) ratio is larger than 80% (this is the ratio of the mortgage amount divided by the appraised value of the home).
Private mortgage insurance rates vary depending on the loan-to-value ratio. A homeowner who only puts 5% down on their home will pay a higher rate than a person who puts down 15%. Rates are based off of the original mortgage amount. For most mortgage companies, the initial monthly payment is set and is not reduced as the homeowner makes mortgage payments and the principal balance of the mortgage declines. However, private mortgage insurance will completely drop off once the LTV value is below 80%. Once a homeowner has made enough monthly payments so the principal balance of the mortgage is less than 80% of the appraised value of the home, private mortgage insurance will no longer be charged. For most mortgage companies, this process is automatic – though you should make sure that this is the case with yours.
Finally, if you are paying private mortgage insurance and you believe your house has appreciated in value, you may be able to have the mortgage insurance eliminated earlier. Because the principal balance is reduced over time, if the appraised value of the home increases the LTV will necessarily decrease – possibly below the 80% threshold. If you think this is the case, contact your mortgage lender, find an appraiser they approve of, and have your home reappraised. If the new LTV is indeed below 80%, you will no longer be charged for mortgage insurance. Be aware, however, that the cost of the appraisal must be borne by the homeowner.