Many of the laws and regulations in place within the housing market are designed to protect buyers from fraudulent practices or other malicious enterprises. However, investors and lenders also need some form of protection against financial loss when a buyer fails to hold up his or her end of the transaction. For these creditors, there is mortgage insurance.

Like other forms of insurance, the mechanism behind mortgage insurance—also known as a mortgage guaranty—is that the insurer receives a premium, which will then be used to cover losses in case the borrower defaults on their mortgage. Generally, a lender will require that mortgage insurance be purchased if the mortgage loan is higher than 80% of the property’s sale price. The lender will decide the amount of loss coverage, which can range from 20–50%, or possibly even higher. The borrower may see the mortgage insurance premium reflected as a part of their mortgage payments, or in some cases the lender will choose to pay these premiums.

Some form of mortgage insurance has existed in the United States since 1880, although it remained an unregulated entity until 1904, when the state of New York passed laws authorizing private companies to issue insurance. At the time, however, insurers were only allowed to cover payments on mortgages owned by the original lender. In 1911, this law was amended to allow lending institutions to purchase and resell loans, and insurers were then encouraged to guarantee the property title as well, to make the mortgages more attractive to investors. For the next two decades these private companies thrived as real estate values climbed, and lenders were pleased to discover that few defaulted properties would sell at a loss. However, the real estate market collapse at the start of the Great Depression severely tested the myriad of bad business practices within the mortgage insurance industry, and as a result, the industry failed.

This failure led to government involvement in the mortgage market, specifically through the creation of the Mutual Mortgage Insurance fund, managed by the Federal Housing Administration (FHA). The FHA uses the fund to insure their own loans to prospective homebuyers, and was expanded after World War II to include war veterans through the Veterans Administration (VA) department. However, both the FHA and VA mortgage insurance programs have legislatively mandated limits to their scope—underwriting guidelines often exclude many prospective homebuyers, for example, and there is a ceiling value past which mortgages may not be insured.

Today, private mortgage insurers succeed or fail based on their ability to identify mortgage risk and decide if they wish to cover it. They may decline to cover a certain mortgage, or adopt strict underwriting conditions based on the property, the buyer’s credit history and job status, or a number of other factors. Within state regulations, they may raise premiums on riskier sales or use methods such as reinsurance or risk pooling to mitigate potential loss. Some mortgage insurers will adopt a strategy of trying to help borrowers in danger of default, through credit counseling and debt management, with the understanding that foreclosure on a property tends to be an unpleasant and costly process for all parties involved.

A home is a major investment for its buyer, which is why smart homeowners purchase adequate insurance to shield them against disaster. The mortgage, however, is an investment by the lender in the dependability of the borrower—and as such, it’s equally as important for them to purchase mortgage insurance to provide a safety net in case the borrower is unable to pay back the loan. Such systems are in place in order to maintain the stability of the housing market, and when they work well, all parties benefit.

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