Mortgage life insurance is an insurance policy that pays all or part of the balance of a mortgage loan if the borrower dies before the mortgage is fully paid off. Mortgage life insurance helps to assure that the borrower’s family will receive a mortgage-free home and that the lender is repaid the full amount of their mortgage loan.
The insurance pays the applicable policy limit to the mortgage lender, not the borrower, but it does benefit the borrower. The lender is the beneficiary of the policy.
Mortgage life insurance, or mortgage protection insurance, is a financial product that also protects the mortgage lender if the borrower defaults on their loan because of their death. This allows lenders to make loans that present more risk, including loans in which the borrower makes a down payment of less than 20% of the purchase price.
These loans are riskier for lenders because the homebuyer has less equity in the home.
Who Purchases Mortgage Life Insurance?
Usually, a person who buys a home buys mortgage life insurance because it is required by their lender. In some instances, homeowners may purchase mortgage insurance as part of their own financial planning. They may realize that the family would no longer be able to afford to pay the mortgage on the home if the homeowner were to pass away and their income were to be lost.
How Does Mortgage Life Insurance Work?
The amount of the mortgage life insurance policy is usually equal to the mortgage balance, up to the insurance company’s policy maximum.
In the standard arrangement, the borrower pays a monthly premium for the insurance coverage. The premium may be billed separately or included as part of the borrower’s mortgage payment. As the mortgage balance declines, the death benefit that would be paid by the insurance company also decreases.
But there are several different types of mortgage insurance, as follows:
- Private Mortgage Insurance (PMI): This is a kind of mortgage insurance that applies to conventional loans, which are home loans that are not backed by the federal government, with a down payment of less than 20%. Conventional loans with PMI coverage make it possible for borrowers with exceptional credit and strong financials to qualify for a home loan with a down payment of as little as 3% of the purchase price.
- There are several different kinds of PMI. For example, Borrower-Paid PMI (BPMI) is the most common form of mortgage insurance. In a BPMI arrangement, the borrower pays a monthly mortgage insurance premium. This amount is added to the borrower’s monthly mortgage payment, so they make only one payment monthly;
- Single-Premium Mortgage Insurance (SPMI): This is single-premium mortgage insurance is paid with a one-time, upfront premium due at the closing of a home purchase;
- Split-Premium Mortgage Insurance: Split mortgage insurance is a hybrid of BPMI and SPMI, allowing borrowers to pay a portion of the mortgage insurance premium upfront and the remainder in monthly installments;
- Lender-Paid PMI: The lender might pay the insurance premium themselves. They would then charge a higher interest rate on the home loan to cover the insurance premiums rather than having the borrower pay the premiums directly;
- Mortgage Insurance Premium: Federal Housing Administration (FHA) loans are designed to help first-time buyers by allowing home purchases with low down payments, low closing costs, and qualification by those with lower credit scores. Currently, homebuyers can qualify for an FHA loan with as little as 3.5% down. Credit score requirements are flexible.
- It is also possible to qualify with a lower credit score if the borrower can make a down payment of 10% or more.
- In exchange for these low down payments and relaxed credit requirements, the FHA requires its own form of mortgage insurance called “Mortgage Insurance Premium.” Regardless of the size of the down payment, all FHA mortgages require MIP. There is an upfront fee for MIP that is equal to 1.75% of the loan amount and annual fees. The annual fees depend on the loan term and loan amount.
With PMI for conventional loans, mortgage insurance must be maintained until the borrower pays down the loan balance to the point where they have at least 20% equity in the home. When they have 20% equity, a borrower can request the cancellation of PMI.
What About VA and USDA Loans?
VA mortgage loans are loans that are backed by the federal Department of Veterans Affairs. They are only provided to those who serve or have served in the armed forces and their spouses. A person can obtain a VA loan with a 0% down payment if they qualify.
A person who obtains a VA loan does not have to obtain insurance, such as PMI or MIP. Instead, they pay a so-called “funding fee” equal to 1.5% of the total mortgage loan amount at the closing of their purchase.
The Federal Department of Agriculture (USDA) offers mortgage loan guarantees that are aimed at giving homeowners an incentive to live in more rural areas of the country. These USDA loans are offered to buyers who have low-to-moderate incomes and buy qualified homes in designated rural areas.
A qualified buyer with a qualified property can get a USDA mortgage loan with a 0% down payment. They do not have to purchase mortgage insurance, but they do pay a guarantee fee. Part of it is paid as an upfront payment plus annual payments after that during the life of the loan. It basically serves the same purpose as mortgage insurance.
How Much Is Mortgage Insurance, and How Is the Premium Calculated?
The specific premium rates can vary among different insurers and loan programs, but here are some guidelines:
- Conventional PMI: The cost of PMI varies depending on a number of factors, such as the loan amount, the amount of the down payment, and the borrower’s credit score. Generally, the average cost of PMI ranges from 0.58% to 1.86% of the original loan amount per year. At those rates, PMI on a $400,000 home with a 3% down payment would cost $2,250 to $7,217 per year or $187.50 to $601 per month.
- A borrower with a higher down payment and a higher credit score is going to pay lower PMI premiums;
- FHA MIP: This premium comes to 1.75% of the loan amount. It can be paid upfront or rolled into the loan and paid in monthly installments with the mortgage loan payment;
- VA Funding Fees: This fee is currently 2.3% of the loan amount for first-time purchases using VA financing and 3.6% for subsequent VA purchases by the same buyer. With a down payment between 5% and 10%, the fee is 1.6% (regardless of whether this is a first purchase or subsequent purchase), and with a downpayment of 10% or more, the fee is 1.4%;
- USDA Loan Guarantee: This fee is currently 1% of the loan amount upfront plus another percentage of the loan amount paid on an annual basis. These fees can be rolled into a person’s monthly mortgage payment.
If a person wants to escape the cost of paying for the mortgage insurance, the borrower would have to refinance their mortgage to a conventional loan once they achieve equity of 20%. This would mean replacing the original home loan with a new conventional loan that would not require PMI.
Problems With Mortgage Life Insurance
Many mortgage life insurance companies do not examine the insurance application until a claim is filed. Because of this, the borrower may be ineligible for the mortgage life insurance despite having paid all of the premiums because of a mistake in filling out the application. Or the borrower may have misunderstood one of the questions.
In addition, mortgage loan insurance simply adds to the cost of buying a home, which is a financially advantageous goal for most home buyers.
Is Mortgage Loan Insurance Refundable?
Mortgage insurance may be refundable under certain limited circumstances. The specific conditions are different with different lenders and loan programs. A person might wish to discuss this feature of a specific policy with a mortgage loan expert.
Generally, the mortgage insurance premiums for FHA loans, funding fees for VA loans, and guarantee fees for USDA loans are never refunded.
Do I Need a Lawyer for My Mortgage Life Insurance Issue?
The application process for mortgage life insurance can be complicated. A mortgage attorney can help you negotiate a mortgage life insurance contract that fits your needs. LegalMatch.com can connect you to a lawyer who can make sure you are getting the best possible deal and that the process of applying is done correctly.
If you need to make a claim, your lawyer can help you succeed with that as well.
