It's a financial guaranty that insures lenders against loss in the event a borrower defaults on a mortgage. If the borrower defaults and the lender takes title to the property, the mortgage insurer (MGIC, for example) reduces or eliminates the loss to the lender. In effect, the mortgage insurer shares the risk of lending the money to the borrower. (Mortgage insurance should not be confused with mortgage life insurance, which provides coverage in the event of a borrower's death, or homeowner's insurance, which protects the homeowner from loss due to damage from fire, flood or other disaster.)
All home buyers can benefit. It allows them to become homeowners sooner, and it dramatically increases their buying power -- excellent benefits from a buyer's perspective. First-time buyers can use a low down payment to help them afford their first home, or to purchase a more expensive home sooner. Repeat home buyers can put less money down and gain significant tax advantages because they will have more deductible interest to claim. They can also use the cash they would have used for a large down payment for investments, moving costs or other expenses.
Without the guaranty of mortgage insurance, lenders normally require a borrower to make a down payment of at least 20% of a home's purchase price, which can mean years of saving for some borrowers. This large down payment assures the lender that the borrower is committed to the investment and will try to meet the obligation of monthly mortgage payments to protect his investment. With the guaranty of mortgage insurance, lenders are willing to accept as little as 5% or 10% down from borrowers. Mortgage insurance fills the gap between the standard requirement of 20% down and an amount the borrower can more easily afford to put down on a purchase. A low down payment also allows borrowers to purchase more home than they might otherwise be able to afford. Without mortgage insurance, a borrower who has saved $10,000 for the required minimum 20% down payment would only be able to purchase a $50,000 home.With mortgage insurance (and income and credit permitting), the borrower could make a down payment of only 10% and purchase a $100,000 home with the $10,000! Or put $7,500 down on a $75,000 home and use the remaining $2,500 for decorating, investing, or buying a car or major appliance. Mortgage insurance broadens a borrower's options.
Generally borrowers do. An initial premium is collected at closing and, depending on the premium plan chosen, a monthly amount may be included in the house payment made to the lender, who remits payment to the mortgage insurer. MGIC offers flexible premium plans for borrowers:
These plans offer the choice of refundable or nonrefundable premiums. A refundable premium allows the borrower the opportunity to receive money back on any unused portion, in the event that mortgage insurance coverage is discontinued before the loan is paid in full. The cost for a nonrefundable premium is slightly less than that of a refundable premium, thereby giving the borrower a small savings. If coverage is discontinued on a loan with a nonrefundable premium, the borrower has no opportunity for a refund.