On the Mission Mortgage blog, we recently covered a couple of stories regarding Mortgage Insurance. In response to our posts, we’ve received a number of questions asking us “What is Mortgage Insurance?”
MORTGAGE INSURANCE: DEFINED
Mortgage Insurance, sometimes called MI, is a program that allows home buyers to purchase a home with less than a 20% down payment. The insurance is protection for the lender in the event of a default. Because the lender allows the buyer to take possession and occupy the home with less than 20% paid down, they are assuming the risk associated with a default or foreclosure. To protect them from these risks, Mortgage Insurance premiums are paid to a central agency or private mortgage insurance provider who will cover the lender’s loss in the event of a default.
HISTORY OF MORTGAGE INSURANCE
Mortgage Insurance originally surfaced in the United States in the 1880s and grew substantially until it becaome completely bankrupt during the Great Depression. The US Federal Government began offering Mortgage Insurance in 1934. No private mortgage insurance providers were allowed again until 1956. In 1956, Wisconsin passed a law allowing privately-backed provider Mortgage Guaranty Insurance Corporation (MGIC) to be chartered and begin offering Mortgage Insurance. MGIC is still a primary provider of Mortgage Insurance today.
More recently, we reported on PMI Mortgage Insurance Group, who was ordered by the State of Arizona to cease writing new Mortgage Insurance policies. They are currently in the process of determining how they will manage their existing client base while they prepare to shutter the company eventually. To see our full coverage of this story, please click here.
MORTGAGE INSURANCE TAX IMPLICATIONS
Another important current concern about Mortgage Insurance is whether or not it will continue to be tax deductable from individual income tax filings. For 2011, our current tax year, Mortgage Insurance remains tax deductible. For more information, you can read one of our previous blog post blog posts by clicking here.
However, during the most recent Debt Ceiling negotiations in Washington DC, the future of the Mortgage Insurance deduction is now in question. The temptation to remove the deduction in order to move towards lowering the federal deficity grew stronger and stronger as the Debt Ceiling debates continued. The end result of the Debt Ceiling negotiations is unclear. The agreement that kept the US Government running did not outline specific reductions or cuts, but did specify that a bi-partisan committee is expected to make recommendations by the end of November. Any changes to the deduction would apply to 2012 at the earliest. To read more about the Debt Ceiling impact on Mortgage Insurance, please click here.
MORTGAGE INSURANCE DETAILS
Specifically, here’s how Mortgage Insurance general works. A home buyer takes out a loan and pays a down payment less than 20% of the purchase price. As a condition of accepting the loan, the buyer must agree to pay a Mortgage Insurance premium. The formulas vary from Government-sponsored Mortgage Insurance to each private provider, but generally include an upfront Mortgage Insurance Premium and/or a monthly premium payment. The Mortgage Insurance contract determines if the premiums stop once the equity in the home reaches the 80% threshold. Generally speaking, premiums are charged for at least 2 years, regardless of equity.
The benefit to home buyers is that they can purchase a home without having to save up a 20% down payment. However, because the risks due to default are greater with borrowers who do not pay at least 20% down, the Mortgage Insurance premium is charged to defray lender losses associated with defaults or foreclosures. The 20% down is an industry standard and does not reflect any specific loss formulas, as far as we could determine. Essentially, the lenders who issues home loans are fairly confident that, on average, a home that is taken back by the bank in the event of a foreclosure could sell for a 20% discount. Thus, the lender can avoid most losses by charging a 20% down payment. But, this leaves a huge majority of the public unable to become home owners, so Mortgage Insurance fills the gap and puts more people into their own homes than would otherwise qualify.
WHAT MORTGAGE INSURANCE IS NOT
It is important to note the difference between Mortgage Insurance and other elements of the home purchase. Mortgage Insurance is not the same as Home Owner’s Insurance. Home Owner’s Insurance is the owner’s protection against certain damages and catastrophes and is unrelated to the loan.
Mortgage Insurance does not provide protection against defaults or foreclosures for the home buyer. Remember, Mortgage Insurance is for the protection of the lender and the premiums are paid by the buyer for the privilege of buying a home with less than 20% down.
Some information for this article comes from Wikipedia. Click here for the Wikipedia post.
Information was also found in this excellent article from HSH.com. Click here for the HSH.com article. This is an excellent article that provides numerical information to explain the theory.