Mortgage insurance is an insurance policy designed to protect the mortgagee (lender) from any default by the mortgagor (borrower). It is used commonly in loans with a loan-to-value ratio over 80%, and employed in the event of foreclosure and repossession.
This policy is typically paid for by the borrower as a component to final nominal (note) rate, or in one lump sum up front, or as a separate and itemized component of monthly mortgage payment. In the last case, mortgage insurance can be dropped when the lender informs the borrower, or its subsequent assigns, that the property has appreciated, the loan has been paid down, or any combination of both to relegate the loan-to-value under 80%.
In the event of repossession, banks, investors, etc. must resort to selling the property to recoup their original investment (the money lent), and are able to dispose of hard assets (such as real estate) more quickly by reductions in price. Therefore, the mortgage insurance acts as a hedge should the repossessing authority recover less than full and fair market value for any hard asset. Mortgage life insurance also guarantees repayment of a mortgage loan in the event of death or, possibly, disability of the borrower.
For example, Mr. Smith obtains a mortgage loan that exceeds 80% (the typical cut-off) of his property's value and/or sale price. Because of his limited equity, the lender requires that Mr. Smith pay for mortgage insurance that protects their institution against his default. To obtain public mortgage insurance from the Federal Housing Administration, Mr. Smith must pay a mortgage insurance premium (MIP) equal to 1.5 percent of the loan amount at closing. This premium is normally financed by the lender and paid to FHA on the borrower's behalf. Depending on the loan-to-value ratio, there may be a monthly premium as well.
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