Mortgage Insurance 101

Who is mortgage insurance protecting?

Due to the larger size of the loan and the evident lack of fluid capital on the part of the borrower, lenders require a substantial premium for assuming the risk of a borrower default.

Say you can't afford a nice house that you want. Nobody wants to deprive you of it, but since you can only pay 5 percent of the price, your mortgage lender justifiably considers your eyes a little bigger than your pocketbook. They'll give you 80 percent, but for the additional 15 percent you will pay a premium. The premium will drop to something considerably less after 10 years. Mortgage insurance, like many financial products, engages in some confusing numbers:
Mortgage insurance quotes

The premium quoted is expressed as a percentage of the incremental loan (that is, the additional 15 percent). The final cost, however, reflects that percentage, say .79 percent, over the entire loan. So if you secure a 7 percent loan on $80,000 but require $15,000 in additional loans, you may end up paying around 12.7 percent for the first 10 years, then 12 percent for the remainder of the term.

Calculating your mortgage insurance cost

Estimating the actual cost of mortgage insurance is not difficult. Swallowing it is another story. Assume you will have the loan at least 10 years. Divide your total loan by the additional loan (in this case, the 15 percent) then multiply it by the insurance premium (.79 percent). 95,000 divided by 15,000 gives you 6.33. When multiplied by .79 percent, you get 5 percent. Go and add that insurance premium to the mortgage rate you worked so hard to get and there is your harsh reality.

But fear not - it is not necessarily a terrible deal. In fact, it can be used to deal with some larger debt or may be the better choice for a successful business person. Observing the choice between ponying up the 15 percent yourself or taking the larger loan with mortgage insurance is just like any investment decision. If you are paying more than 12 percent to creditors, you certainly want to take the larger loan and settle the credit debt as soon as possible. Likewise if you are running a business that returns more than 12 percent; you should keep your cash and take the mortgage insurance. However, if you are holding on to a stock portfolio currently returning 7 percent, it's best to liquidate it and buy your house with a larger down payment.
Something to consider

Ultimately, you need to do some speculation. Nobody knows how your home will appreciate, which should certainly be a considerable factor in your decision. If you expect substantial appreciation, the 12 percent you save by not getting mortgage insurance may end up being closer to 15 or 20 percent.

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