What is Mortgage Default Insurance and How Does it Work?

There are a lot of expenses that must be paid when you buy a home: the down payment, the principal and interest on the mortgage loan itself, closing costs, attorney fees, and other determined costs all add up to a significant figure. When you can only afford to put a down payment of less than 20% onto a mortgage loan, you can expect to pay another monthly fee, on top of your principal and interest: mortgage default insurance.

Those who offer a down payment of 5% to 19.99% will be made to pay this additional amount each month. For those who have been enamored by the idea of paying a lower down payment than a conventional mortgage requires (20% of the home’s total value), being told of this additional expense can be quite surprising. That’s why we’re here to break down what you need to know about mortgage default insurance – before you put up that smaller down payment.

It’s also worth mentioning that mortgage insurance is typically needed for the first mortgages and not private or second mortgages.

Who Does the Insurance Protect?

While you might be accustomed to purchasing insurance that protects you in the event of a catastrophe, mortgage insurance doesn’t work the same way. Instead, you’re making monthly payments on an insurance policy that protects the lender rather than you, the borrower.

Why is Mortgage Default Insurance Necessary?

Mortgage default insurance is only mandated if you put up a down payment of less than 20%. If you are able to pay that 20% or more, you’ll enter what is known as a “conventional mortgage.” Mortgage loans begun with a smaller down payment are referred to as “high-ratio mortgages” and present a greater perceived risk to the lender.

To protect themselves from the event of a default, mortgage insurance is necessary. If you fail to make the monthly payments on your mortgage loan, they will be able to collect the amount you’ve paid toward this insurance as compensation.

How Much Does This Insurance Cost?

Home buyers can expect to pay anywhere between 2.8% and 4% of the mortgage loan amount when they are obligated to buy mortgage insurance. If you are choosing to buy a home valued at $1 million or more, however, a high-ratio mortgage (even with mortgage insurance) is entirely out of the question. Conventional mortgages are the only mortgage types available for houses of that high a value.

How Can You Reduce the Cost of Your Mortgage Insurance?

If a 20% down payment is entirely out of reach, you could still save a little bit on your mortgage insurance if you do one of two things:

  1. Choose to buy a less expensive home.
  2. Increase your down payment as much as you can, even if it’s not near 20%.

How Does One Pay Their Mortgage Insurance Costs?

Unlike closing costs and other fees associated with the home-buying process, mortgage insurance is not paid in a singular lump-sum. Instead, it is added to your monthly mortgage costs. So, instead of paying only the principal and the interest on your mortgage loan, you will be paying interest + principal + mortgage insurance.