What Is Mortgage Insurance and What Does It Do for Me?

February 11, 2009

Finance

Confused By Insurance?<br>You're Not Alone.
Confused By Insurance? You

There seems to be a lot of misunderstanding and many misconceptions around what mortgage insurance (MI for short) actually does. Mortgage insurance is typically required on mortgage loans where the amount borrowed is 80% or more of the appraised value. The other distinguishing characteristic of mortgage insurance is it can be expensive.

Mortgage Insurance Is for Lenders, Not Borrowers

I a friend of mine asked me, ?Where are all the MI companies in all this mess? Shouldn?t they be helping stem some of these foreclosures??  Well, MI is actually to cover the lender’s butt, not the borrowers. Let’s say somebody buys a house for $200,000, puts $10,000 down, and finances $190,000. Let’s say they live in the home for a year, and then start running into trouble. Over the year, they got the principle balance down to only $189,000 (yes, your first couple years of mortgage payments are mostly interest). At first they’re slow with their payments and eventually they don’t make payments, go into foreclosure, and 9 or 12 months later, finally have to leave the house.

A year’s worth of interest, which was not paid when the mortgage went unpaid, at 6.25% on this loan would be approximately $12,000. This means the total to pay off the debt would be $201,000. (It would actually be higher because of court costs and attorney fees.) Foreclosed houses typically get auctioned off for around 50-70% of the the true value?even less if the home is in bad condition?which means the lender just lost $60,000 to $100,000.

This loss is what the mortgage insurance covers. It?s an insurance policy to cover lender’s losses that must be paid for by the borrower. That?s right, the homeowner pays, and the bank benefits. Hardly seems fair, right? Well, I don?t make the rules; I just play within them. But, to be fair to the banks, they still lose tens of thousands on a foreclosure, even with MI, because the MI typically only covers 25-35%. Also, as you can see from the above scenario, the losses can be much greater than that.  And, the above scenario has been happening, as you probably already know, way too often. That’s why, along from lenders, the MI companies have been tightening up guidelines too.

Mortgage Insurance Not Always Available

This makes mortgage financing more difficult, because a bank or lender will not make a loan if mortgage insurance is required but not available for a given scenario. And it?s because of these huge losses associated with foreclosure that so many banks and lenders are willing to negotiate with borrowers who are in trouble; taking a smaller, short-term loss can help prevent a much larger one.

Mortgage Insurance Is Tax Deductible

On a positive note, mortgage insurance?along with mortgage interest and real estate taxes?is tax-deductible. It wasn?t always so, and I wouldn?t be surprised to see this deduction disappear sometime soon.

Photo by Pirate Alice

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About Brad Walbrun

Brad Walbrun grew up in northeastern Wisconsin, moving to Chicagoland over a decade ago, and never to return, although he remains an avid Packer fan. He is married, with 3 children, living in Schaumburg. Brad's passions are fitness, MMA, and mortgages. He has been in the mortgage industry since before the refi boom, for almost 10 years now. You can reach Brad at (847) 975-4440 or bradwalbrun@hotmail.com.

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