Mortgage insurance covers the mortgage lender in case you default on your loan; while it doesn't have many benefits for borrowers, it does have a few. It's important to know how mortgage insurance works and when you can safely terminate it.
Mortgage insurance is a type of insurance policy that refunds the lender of the mortgage if the borrower neglects to make his payments, or if he dies before the mortgage is paid off.
Mortgage Insurance Significance
Mortgage insurance protects the lender who holds a borrower’s mortgage. In case the borrower defaults, the lender and the borrower are protected. New home buyers are generally required to have mortgage insurance if their loan has below 20 percent equity. Equity is the amount in the house the homeowner owns outright, not subject to a mortgage loan. In other words, if you put a 15 percent down payment on a house, you will likely be required to have mortgage insurance.
Mortgage Insurance Benefits
Mortgage insurance basically allows buyers who are not able to make a large down payment to purchase a home. In essence, mortgage insurance allows you to make a low down payment on your home. If mortgage insurance did not exist, this would not be possible due to the high amount of risk lenders experience. As of 2018 and the new tax bill, mortgage insurance payments may no longer be deducted from the borrower’s taxes. The real benefit of mortgage insurance is for the lender: the premiums you pay protect the lender in case you are unable to pay your mortgage.
Timeline and Termination
If a homeowner defaults on the mortgage, mortgage insurance covers them for at least a year, but often longer. Depending on the mortgage, homeowners may be able to stop paying mortgage insurance at a certain point. Most traditional mortgages require that homeowners pay for mortgage insurance for the first year after they take out a loan. Once the balance that you owe on your loan is less than 80 percent of the purchase price, you can request that the lender terminate the insurance.
In other cases, if you remodel your home and it is appraised at a higher value that grants you 20 percent equity, the lender may terminate the insurance. FHA guaranteed loans require mortgage insurance payments for a minimum of five years.
If you are considering terminating your mortgage insurance, make sure you will be able to make payments: once you cancel your insurance, you will no longer be covered if you default on your mortgage.
Other Things to Consider
While mortgage insurance is necessary and allows many families to purchase a home, it is important to know when you should cancel your plan. If you reach a point at which you are no longer required to hold mortgage insurance and feel confident about your ability to pay your mortgage in the future, it may be a good idea to cancel the insurance to avoid overpaying.