What Is Mortgage Insurance?

Certified Mortgage Advisor
NMLS 1701021
Published 
November 29, 2018

Mortgage insurance: Things that you need to know

Let's talk about mortgage insurance. What is it, do you need it, and is it harmful or is it helpful? And we'll talk about some different cost analysis options that you have with mortgage insurance.

What is mortgage insurance?

So right upfront mortgage insurance is the portion of your monthly loan payment. That goes to the lender to protect them in the event of a default on a loan. So it's a small monthly cost if you're putting less than 20% down on a loan.

We want the best investment for our future

So when we're structuring our loan, we wanna make sure that our monthly payment is creating the best asset for us possible. That way in the future, when we go to sell the property, we have the most equity stored up in the property. So we have more money to go either pull out or to go put into a new property.

Mortgage insurance is to protect the lender

So the struggle with mortgage insurance is that unfortunately, mortgage insurance doesn't go towards anything to help you as a buyer mortgage insurance is sole to protect the lender in the event that a borrower defaults on a loan. Now from a global economic scale, this is great because it really protects our economy.

Can open up some opportunity to free up some money

But on an individual level, what it feels like is like we're paying a hundred dollars maybe per month. When we're putting less than 20% down and it feels like a wasted cost, I wanna show you how mortgage insurance actually opens up some opportunities for you to free up some cash and be more flexible with the way that you use your money.

How much mortgage insurance will we pay?

So we cover that mortgage insurance is paid by the lender. So let's talk about how much mortgage insurance normally is.

Conventional

Now, if we're talking about a conventional loan mortgage insurance really is going to depend widely based on your credit score. As well as the down payment amount. So if you have poor credit, you're going to have higher mortgage insurance per month. And if you have grade credit, you're gonna have lower mortgage insurance per month. Now that's with a conventional loan.

FHA

With FHA, it's a set standard for how much mortgage insurance you pay per month. So if FHA is an in for you then you'll know that mortgage insurance will be pretty constant across the board, depending on the loan size.

But with conventional, it's going to depend a lot on how good you are as a buyer. So something that we need to keep in mind is that when we're setting up our mortgage, we need to treat this as a financial investment and not get too caught up in the emotional weight of the monthly payment. We need to have a broader perspective of what we're doing.

Decision based on future value, not emotions

So let's set that in place now, but we're making decisions not based on emotions. We're basing them on what is the future value and the opportunity cost that we have with the loan that we set up.

Scenario

So let's go ahead and consider the cost of mortgage insurance and what this is going to look like. So I'll walk through it with you. So let's assume that we have a purchase price on a property for $200,000.  Now we're going to make a down payment of $10,000, which is 5%. So that gives us a loan amount of $190,000. So 200 minus $1,000 is $90,000.

Now since we're putting less than 20% down, let's assume that it's $90 per month. So we're making $90 per month as a payment to mortgage insurance.  As part of the total mortgage payment. So this might feel like that man that's $90, it's going towards nothing.

It seems like it's only to protect the lender. Let's actually look at what we're freeing up. When we choose to take this option of 5% down. Right now, in this scenario, we're only having to free up $10,000 in cash to be able to put a down payment on this $200,000 property. So if we wanted to take off mortgage insurance and remove this $90 per month, we would have to put 20% down.

Now, 20% down on this property would be $40,000. So you can see where we're going here. If we put 5% down, we only have to use 10,000. If we put 20 sent down, we have to put down, we have to spend $40,000. So the difference here is $30,000. So if we spend an additional investment of $30,000, we will take off this $90 per month.

Now, if we're looking through a break-even, so if we're taking this $90 and dividing it into 30,000, what's gonna take 333 months to break even, or 27.8 years.  Now, this mortgage insurance over here, we're talking about equity that's in the property, and mortgage insurance will never be equity in the property, but this is where the cost analysis starts to come in.

We can use it for other investments

When we're looking at mortgage insurance, is it actually that bad? Because even though we're paying $90 a month, we have $30,000 free in cash to be able to use. For other investments, college savings, anything else that creates a positive return on your money? So in this scenario, what if instead of putting $40,000 down to remove mortgage insurance, what if instead, you put 5% down.

So $10,000 you paid $90 per month in mortgage insurance and then you took the extra $30,000 and you purchased an investment property or two investment properties. Do you think that with $30,000 you could invest in another investment vehicle other than a house other than the primary residents that would net you $90 per month or more? I would hope so, especially if you're looking at other investment properties.

It's not an equity

So again, mortgage insurance is not going to be equity. This will not be equity in the property. But it's something to consider by being able to use debt to leverage the purchasing power that we have. So, we wanna make sure that we're making the most financially wise decision for when we're setting up a loan and purchasing a house.

Still, it's creating opportunity for you

So really mortgage insurance doesn't view it so much as this most baggage that feels like it's getting paid to do nothing for us every month. Look at it more like the opportunity that it's creating for you. Even though it's a monthly payment, it's freeing up your ability to have more flexible cash to put into other investments that will be creating some positive returns for you.

Let's think that mortgage insure is a positive thing

So this is mortgage insurance in a nutshell and some different ways to look at it instead of this, just as an expense or this emotional payment that feels like it's going nowhere. Mortgage insurance really can be an opportunity to free up cash. So you don't have to put 20% on a house.

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