WHAT IS MORTGAGE INSURANCE?

What, exactly, is mortgage insurance? Well, first let�s tell you what it�s not. It�s not an insurance policy that pays the mortgage if someone becomes disabled, ill or unemployed and can no longer make the monthly payments. Instead, mortgage insurance is a policy that pays the lender a certain amount should the loan ever go into default. Here�s how mortgage insurance works and where it came from.

Conventional mortgage loans from banks for the longest time required a down payment of at least 20 percent before issuing a loan approval. Unlike government-backed loans such as VA, FHA and USDA programs, if the home went into foreclosure there was no compensation to the lender for the loss. Instead, the bank had to take back the home and sell it once again and encountering costly legal and settlement fees.

Yet coming up with a large down payment was difficult for most and it took borrowers longer to save up enough money for a down payment plus closing costs. In 1958, a company called Mortgage Guaranty Insurance Corporation, or MGIC, introduced a new type of insurance policy that would allow buyers to put provide a lower down payment. The policy would cover the difference between what the lender originally required for a down payment and what the borrowers actually paid.

For example, let�s say a lender required a minimum down payment of 20 percent of the sales price of a home. On a $300,000 price, that equals $60,000 for a down payment. Instead, the borrowers put down just 5.0 percent, or $15,000 leaving a $35,000 shortfall. Mortgage insurance then covers the $35,000 shortfall should the loan ever go into default. It�s a simple concept that has been in place ever since and today there are multiple companies that provide such coverage.

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