There are few dirtier words to the average home buyer than “mortgage insurance.” Article after article has been written on ways to avoid mortgage insurance and on why it’s an awful, terrible thing, but I’m here to tell you something new. Mortgage insurance isn’t always a horrifying scar on your mortgage paperwork. In fact, mortgage insurance is busy helping you every day, even if you don’t know it.
Pay attention, because you’re not likely to hear this again from anyone writing about mortgages. Mortgage insurance can be your friend, it can help you out of a jam and it can change the entire economy if it’s used properly.
Mortgage Insurance Basics
Mortgage insurance comes in many forms. For conventional loans, we just call it private mortgage insurance (PMI), on FHA or USDA loans it’s MIP (mortgage insurance premium), VA loans include it in the Funding Fee. Even loans that are considered “no mortgage insurance” loans raise the interest rate of the product in order to provide your bank with a way to pay for mortgage insurance premiums. The truth is, if you’re bringing less than 20 percent down for a mortgage loan for your home, you’ll pay mortgage insurance one way or another.
But, that’s really not an all bad thing, believe it or not. Yes, it’s true that the the mortgage insurance you’re paying is to insure against your mortgage going bad (aka. your going into foreclosure) and it’s true that it only pays to the bank when this happens. However, as much as we don’t like to think about foreclosure and we don’t like the bank benefiting from our misfortune, this insurance is not just for them. It’s also for you.
Your MI is Helping Banks Help You Better
At this point, I’m sure you’re ready to throw rocks at the screen, but hear me out. Mortgage insurance is a good thing, even if it feels like it’s a bit on the pricey side sometimes. This is not one of those insurances you never use, like your dental coverage, you actually benefit from mortgage insurance every single day that you’re a homeowner, even if your mortgage insurance has been lifted and you’re no longer paying premiums.
These are just four of the ways that mortgage insurance helps you, either once or all the time — and sometimes both, depending on how you look at it:
Allowing for Riskier Lending. Believe it or not, low FICOs aren’t the only thing that scares the beejeebus out of banks when it comes to lending. Credit applicants with very little credit history are equally terrifying, no matter how good that limited credit is. Mortgage insurance has been a feature of risky loans since 1956, when MGIC was chartered as the first insurance company of its kind.
Lending had fallen off as a result of the fall of the insurers of the pre-Great Depression era, leaving a gap in the market for lenders and borrowers alike. This is about the time the FHA was founded to provide loans for riskier borrowers, but lenders were still hesitant to make these loans despite the government’s promise to buy the mortgages right away. As a result, dedicated mortgage insurance companies were born, along with a whole lot of legislation to control them.
With all this security, bigger lenders were much more likely to make loans to riskier credit profiles, whether that was a first time home buyer, someone with a black mark deep in their credit history, or a buyer with a smaller than usual cash reserve. It’s because of mortgage insurance that more people can own homes today, allowing for higher property values and a healthier real estate market overall.
Allowing You to Bring Less than 20 Percent Down. Even if you’re not a particularly risky looking buyer, if you have anything less than a wheelbarrow full of money to use as a down payment your bank would have raised an eyebrow before mortgage insurance. With the promise of mortgage insurance to cover the portion of your loan above an 80 percent loan to value ratio (if your house is $200,000 and your loan is 95 percent or $190,000, this portion would be the 15 percent or $30,000 between the 80 percent LTV of $160,000), there’s very little risk to the bank.
In the case of default, your lender will file a claim against your mortgage insurance to help recuperate their loss on the property. Often, between the home sale and the mortgage insurance, the bank is able to cover your entire loan plus any costs associated with selling the property. So, for them the risk is fairly low with this type of insurance in place.
That means a better interest rate for you, better products to use for purchase with a smaller down payment and lower fees overall. Mortgage insurance makes buying a home affordable, even if it might seem like an extra payment you’re making for nothing.
Giving You an Extra Tax Deduction. If you’re looking for extra tax deductions on your Schedule A, don’t forget your mortgage insurance. If your insurance policy was issued after 2006 (you purchased or refinanced after this date) on a home that you use as a personal residence, you can often take the real cost of your mortgage insurance for the year as a deduction.
Even if your mortgage insurance was upfront only, like what’s used with many USDA and VA loans, there is a way to deduct it from your taxes. It’s important to note that if you have more than $50,000 of adjusted gross income as a single tax filer or $100,000 as married filing jointly, you may not be able to deduct all of your mortgage insurance.
Generally, you’ll receive a Form 1098 in January with the total amount of mortgage insurance you paid in the last year in Box 4. This form also reports how much interest you’ve paid, which is another not to miss deduction if you itemize.
Protecting You in Case of Default. Nobody wants to think about having to face foreclosure but sometimes a string of bad luck means that it may be the only choice available to you. When you can’t sell your house and you can’t make the payments due to a situation beyond your control, your options start to shrink by the day. If you’re one of those people who elected to pay mortgage insurance rather than looking for a way around it, you’ve invested in a layer of protective financial armor.
When a house goes into foreclosure, the bank has the right to sue you for the difference between what you owe and the amount it was able to sell for in many states. This means that even after the nightmare of losing your home is over, you may still have to pay more out of pocket. If you have a mortgage insurance policy in place, it will often cover that missing money, provided you’ve not done something disfiguring to the home and that your property value hasn’t taken a nosedive.
This is what you’re actually paying for with mortgage insurance. If you bring less than 90 percent down, your lender will buy a 25 percent coverage plan, 85 to 90 percent down will dictate a 12 to 17 percent mortgage insurance policy and 80 and 85 percent down requires six percent coverage. Although a mortgage insurance policy isn’t a guarantee that you won’t be sued by your lender during a foreclosure, it’s a good bet that they’ll take what they can get and leave you be, especially if your property was your primary residence and you never refinanced the loan.
The Bottom Line: Mortgage Insurance Has Some Benefits
As you can see, there’s a lot more to mortgage insurance than just being a junk fee you have to pay in order to get a mortgage. It’s great stuff, it’s doing a ton for you and when you pay in, you help other first time buyers become homeowners by lowering the lending trepidation that banks feel. Of course, it’s not a fix all — obviously the recent mortgage crisis happened despite many of those loans being backed by mortgage insurance.
If you absolutely, positively cannot bear the idea of paying for mortgage insurance, there are other options. You can use a piggyback mortgage instead, build equity in your home by making valuable upgrades and have a new appraisal, pay your mortgage down to the 80 percent point and ask that your mortgage insurance be removed or refinance into a product with low to no mortgage insurance premium.
Ultimately, it’s up to you whether you want to pay mortgage insurance, but if you do, know that you’re not just throwing your money away. Your mortgage insurance policy can be the one thing that keeps you out of hot water if your mortgage goes south, and it can serve as a hefty tax deduction if you itemize. It’s also there to help make loans like yours and the one of your home’s potential future buyers possible in the first place.