When a mortgage company lends money so someone can buy a home, the home serves as collateral.  Should the borrower be unable to pay the amount he or she owes, the lender can take possession of the home and sell it to get the loan amount back.  Lenders want to reduce their risk as much as possible.  In situations where the lender is concerned that the value of the home might not be enough to cover the loan amount, the mortgage company buys mortgage insurnace. This, basically, answers the question, “what is mortgage insurnace?” Should the borrower default on the loan, the insurance company will be required to make up any difference between the value of the home and the loan amount.

The insurance premiums are passed on to the borrower, who pays them in a single up-front payment, annually, or monthly as part of the mortgage payment.  These insurance policies might be called either Lender’s Mortgage Insurance or Private Mortgage Insurance, often abbreviated PMI.

Typically, a lender will require mortgage insurance if the difference between the appraised value of the home and the amount loaned is less than 20 percent of the home value.  In other words, if a home is appraised at $100,000 and the loan amount is greater than $80,000, the lender will require insurance.  For most home buyers, a down payment of 20 percent or more is not possible, so insurance is required in most situations.  Because the premiums are typically paid by the month, PMI increases the borrower’s total monthly payment.

The lenders choose the company from whom they buy the insurance, but the borrower must pay the premiums.  This leads to controversy, since the free market doesn’t come into play.  Unfortunately, the buyer has no choice if she wants the loan to go through.

Typically, the borrower is only required to pay for mortgage insurance for approximately 7 years or until such time as the loan or house value relationship is over 80 percent.  The relationship changes as the loan is paid down or as the value of the home on the open market increases.  Both government and private institutions can offer insurance, however all companies must follow the guidelines of the Federal Housing Administration or FHA.