A mortgage insurance premium is a fee paid by a homeowner to insure a residential mortgage against losses stemming from a mortgage default. Lenders typically require borrowers to purchase mortgage insurance if they are buying homes with small down payments. Existing homeowners are sometimes required to purchase mortgage insurance as a result of refinancing a home.
When homeowners default on mortgage payments, lenders can seize the property secured by the loan and sell it at a foreclosure sale. The sale of a foreclosed home may raise sufficient funds to cover the mortgage but if it does not, the lender usually has to write-off the remainder of the debt. To reduce the risk of losses tied to foreclosures, lenders require people to make down payments when buying homes. Rules on the down payments vary, but in the United States conventional mortgage products involve a borrower financing no more than 80 percent of the value of a home. People who take out loans with higher loan-to-value ratios must purchase mortgage insurance.
Mortgage insurance only covers a portion of the value of a financed home. Lenders require borrowers to buy mortgage insurance equal to the difference between the amount of a conventional mortgage down payment and the down payment made by a borrower taking out a low-down payment loan. In the United States, if a borrower makes a down payment of 5 percent, mortgage insurance coverage limits should amount to at least 15 percent of the property value so that the lender's exposure does not amount to more than 80 percent of the property's value. People refinancing must buy mortgage insurance if the new loan exceeds 80 percent of the property value.
Borrowers make mortgage insurance premium payments on a monthly or annual basis. The insurance company providing coverage deposits premiums into a cash reserves fund and makes payouts when lenders file claims. Mortgage insurance premium costs are based on the size of the loan. The cost of mortgage insurance premium payments can cause a borrower's monthly payments to rise significantly, but borrowers who have built up at least 20 percent equity in their homes can drop mortgage insurance.
During recessionary periods, home prices sometimes fall due to an imbalance of supply and demand. Falling home prices expose insurance companies to greater risk levels because more lenders rely on mortgage insurance payouts to cover losses tied to foreclosure sales. Insurance companies address this issue by either raising mortgage insurance premium costs or refusing to insure homes in areas with steadily falling home prices. In the absence of mortgage insurance, lenders no longer offer low down payment loans, which makes it harder for people with minimal savings to buy property.