Mortgage Insurance Explained
When taking out a new home loan you will often be charged for something called mortgage insurance.
Mortgage insurance is generally required for a loan if you have less than 20% deposit or equity, however it can vary with some lenders, especially for non-standard mortgages.
There is a lot of confusion amongst homeowners when it comes to mortgage insurance, and in this article we will try to clear up some of this confusion.
What Does Mortgage Insurance Cover?
Mortgage insurance protects the lender against a home selling for less than the lender is owed.
The easiest way to explain mortgage insurance is to give an example. Let’s say you had a mortgage of $400,000 and the lender had to repossess you home because you could not continue making the repayments.
The lender would then have to sell the home, with three possible outcomes:
- The home sells for more than $400,000. In this case the bank would take their $400,000 to cover the mortgage, and any remaining funds would be paid back to you.
- The home sells for exactly $400,000. In this case the lender would take their $400,000 to cover the mortgage and there would be nothing left over for you.
- The home sells for less than $400,000. In this case the lender would be left out of pocket, because the proceeds from the home would be less than the mortgage. As the borrower you will still be liable for the shortfall.
The lender does not want to take the risk of chasing you for the shortfall, because they already know that you cannot afford your repayments to start with. To cover this risk they take out mortgage insurance.
Let’s say your home sold for $350,000, leaving a shortfall of $50,000. The mortgage insurance provider would pay $50,000 to the lender to cover the lender’s loss, but as the borrower you are not out of the woods yet.
The mortgage insurance provider will then chase you to recover their $50,000. Obviously this will be quite difficult given that you couldn’t afford the repayments to start with, but that is something that will be worked out between you and the insurance company.
Why Do I Have To Pay A Mortgage Insurance Premium?
Although mortgage insurance doesn’t cover you for any financial loss, it does help you by allowing you to purchase a home with a lower deposit.
In the past banks would only give a mortgage to someone with a deposit of 20% or more. 20% was seen as a safe buffer in the case that a home had to be repossessed and had dropped in value.
For many Australians saving a 20% deposit was near impossible, so insurance companies devised a type of insurance that would protect the lenders and allow people to take out mortgages with much lower deposits.
The reason that you have to pay the premium is because mortgage insurance is there to help you obtain a mortgage, even though it may not offer any protection down the track. Without mortgage insurance the lender would not give you a mortgage with less than 20% deposit.
How Much Does Mortgage Insurance Cost?
The cost of mortgage insurance can vary from a few hundred dollars to many thousands of dollars. Higher loan amounts will bring higher premiums, and lower deposit percentages will also attract higher premiums.
For example a person with a 5% deposit will pay a far higher premium than someone with a 15% deposit. Someone with a 20% deposit or higher will generally pay no mortgage insurance.
Are There Other Forms Of Insurance To Protect Me?
There are no forms of insurance that protect you from your home falling in value, but there are a number of insurances that can protect your mortgage in the event of illness, injury or death.
Life insurance can cover your loan if you die or are diagnosed with a terminal illness, and other forms of insurance such as income protection, TPD insurance and trauma insurance can help to cover your mortgage during times of illness and injury.