Mortgage guarantee products can provide a sense of security for both lenders and borrowers. These products offer protection by guaranteeing the repayment of a mortgage if the borrower defaults. This added layer of security can make it easier for buyers to secure a loan and often leads to more favourable loan terms. In this article, you’ll learn about the top mortgage guarantee products available and how they can benefit both lenders and homebuyers.
See also: Difference between home loan and mortgage loan
Meaning of mortgage guarantee products
Imagine you take a loan to buy a house and promise to repay it. A mortgage guarantee product works like insurance for that promise. Normally, with traditional mortgages, the bank trusts only you to make the payments. But with a mortgage guarantee product, there is a third person, called a guarantor, who promises to pay if you can’t make your payments.
How does this work?
The guarantor
This is usually a special financial institution, like the Indian Mortgage Guarantee Corporation (IMGC). They look at the borrower’s profile and guarantee a part of the loan (usually up to 80%).
The lender
Banks and housing finance companies can buy this guarantee from the guarantor. This lets lenders give loans to people who might not qualify for regular mortgages because of a lower credit score or higher loan-to-value ratio (how much you borrow compared to the property’s value).
The borrower
If you, the borrower, can’t repay the loan, the lender gets the guaranteed part of the loan back from the guarantor. This helps protect the lender from losing a lot of money.
Comparison with traditional mortgages
| Feature | Traditional mortgage | Mortgage guarantee product |
| Eligibility | Stricter credit score and down payment requirements | More relaxed eligibility for borrowers with lower credit scores or higher loan-to-value ratios |
| Risk | Higher risk for the lender in case of default | Lower risk for the lender due to the guarantee |
| Cost | Lower interest rate | May have a higher interest rate due to the additional risk covered |
| Availability | Widely available | Less common than traditional mortgages |
| Guarantee coverage | None | Covers a portion of the outstanding principal and interest in case of default |
Benefits of mortgage guarantee products
For borrower
- Easier access to loans: Borrowers have a better chance of getting a mortgage. With less strict requirements, even those with lower credit scores or smaller down payments can get approved. This is great for first-time homebuyers who haven’t saved much for a down payment.
- Lower down payments: Since the guarantor takes on some of the risk, lenders might be willing to accept smaller down payments. This means borrowers can buy a home sooner without needing a big upfront payment.
- Better loan terms and lower interest rates: Sometimes, borrowers with a mortgage guarantee can get better loan terms or lower interest rates. This can mean smaller monthly payments and save a lot of money over the life of the loan.
For lender
- Reduced risk of default: Lenders benefit greatly because they face less risk of borrowers not paying back their loans. If a borrower can’t pay, the guarantor steps in and pays part of the loan, so the lender doesn’t lose as much money.
- Increased willingness to approve loans: With the guarantee in place, lenders feel more comfortable approving loans for people who might normally be seen as risky because of their financial situation. This helps lenders grow their business by offering more loans.
- Protection of investment: Lenders protect their money because the guarantee ensures they won’t lose all their investment if a borrower can’t pay. This makes lending more stable and reliable for lenders.
Read also: What is a mortgage cancellation deed?
Types of mortgage guarantee products
Government-backed guarantees
These guarantees are supported by government agencies and are designed to help homebuyers who may have lower credit scores or limited down payments.
Private mortgage insurance (PMI)
This type of insurance is provided by independent insurance companies and is required for conventional mortgages with a down payment of less than 20%. Borrowers pay a premium for PMI until they reach 20% equity in their home (meaning they’ve paid off enough of the loan).
Lender-paid mortgage insurance (LPMI)
Similar to PMI, but in this case, the lender pays the insurance premium instead of the borrower. This can be beneficial if you have a lower credit score or limited funds upfront. However, lenders might charge a slightly higher interest rate to cover this cost.
Piggyback loans
This involves taking out two loans to avoid paying PMI. The first loan covers 80% of the home’s value, and the second loan covers the remaining amount. If the combined loan-to-value ratio exceeds 80%, PMI may still be required.
Mortgage insurance for high loan-to-value (LTV) loans
This type of insurance covers loans with a high loan-to-value ratio, typically between 80% and 95%. It provides additional security for lenders when borrowers make smaller down payments. However, borrowers pay a premium for this added protection.
Eligibility criteria for borrowers
- Credit score: Mortgage guarantee products can accept a wider range of credit scores than traditional mortgages, but you still need a minimum score.
- Debt-to-income ratio (DTI): This ratio compares how much you owe each month to how much you earn. A lower ratio shows better financial health and improves your chances of getting approved.
- Employment history: Having a stable job for at least two years is important to lenders.
- Down payment: Some programs let you pay a lower down payment (like 3.5% for FHA loans), but others may need the standard 20%.
- Property type and location: Some guarantee programs may limit the types of homes or where they can be located.
Required documentation
- Proof of Income: You’ll need to show pay stubs, tax returns, and W-2 forms to prove how much you earn.
- Employment verification: Lenders might contact your employer to verify that you have a job and to confirm your income.
- Asset verification: Bank statements and investment records may be required to understand your overall financial situation.
- Credit report: They’ll check your credit report to see your credit score and history. If your score is lower, you might need a higher down payment or a co-signer for some programs.
Calculating the premium
The main cost of a mortgage guarantee product is the premium. This fee is paid by the borrower to the guarantor, like a mortgage insurance company, for guaranteeing the loan.
The premium can be calculated in a few ways:
- Flat fee: This is a fixed fee added to the loan amount. You pay it once.
- Percentage of loan amount: It can also be a percentage of the original loan amount. You might pay it upfront or spread it out over the loan term.
- Risk-based: The premium could depend on factors like your credit score and the loan-to-value ratio. Higher risk factors usually mean a higher premium.
Upfront vs annual/monthly fees
Premiums for mortgage guarantee products can be structured in different ways:
- Upfront: This means you pay the premium as a lump sum when you close the mortgage deal. Sometimes, this amount is added to your loan.
- Annual: You pay this premium once a year, on top of your regular mortgage payment.
- Monthly: This premium is divided and paid every month along with your usual mortgage payment.
Cancellation or reduction of premiums
If you have PMI, you can stop paying it once you’ve paid off enough of your mortgage to own 20% of your home’s value. Just be aware that there might be fees for cancelling it. For other types of mortgage guarantees, the rules on reducing or ending premiums can vary. It all depends on the specific program and the lender you’re dealing with.
Common myths
Mortgage guarantee products are always more expensive than traditional mortgages.
While traditional mortgages avoid PMI with a 20% down payment, guarantee products with lower down payments can save money in the long run. PMI can often be cancelled once you build enough equity in your home.
You automatically save money by choosing a mortgage with the lowest interest rate.
Consider all costs, including interest rate, upfront fees, and ongoing premiums. A slightly higher interest rate with a guarantee product might be balanced out by lower initial costs or the ability to cancel PMI later.
Only borrowers with bad credit can qualify for mortgage guarantee products.
Many guarantee products cater to a wider range of credit scores compared to traditional mortgages that demand larger down payments.
Mortgage guarantee products are difficult to obtain.
The application process for most guarantee products is similar to traditional mortgages, but eligibility criteria can vary by program.
Mortgage guarantee products are a waste of money because they don’t benefit the borrower.
These products increase your chances of homeownership with a lower down payment and provide security in case of default.
Guarantee products are only for risky borrowers and come with many restrictions.
While some programs have stricter terms, many offer a path to homeownership for a wider range of borrowers and allow for benefits like PMI cancellation.
Tips for choosing the right mortgage guarantee product
Assess your needs and goals
- Decide how much you can afford to put down. A higher down payment can lower costs.
- Know your credit score to see which guarantee programs you qualify for.
- Check your income and debts to manage extra costs from a mortgage guarantee.
Research different options
- Look into FHA loans (easier to qualify) or VA loans (for veterans and military).
- Compare rates and rules for PMI from different lenders.
- Understand how LPMI affects your interest rate and upfront costs.
Consider the costs
- Compare upfront, yearly, or monthly fees for different guarantee products.
- Some guarantee programs may have slightly higher interest rates.
- Choose a program that lets you cancel PMI once you build enough equity.
Compare
- Check with multiple lenders to compare rates, fees, and guarantee options.
- Inquire about any deals or incentives for choosing a specific guarantee program.
Seek professional guidance
- Talk to an expert who can explain different guarantee products and recommend the best fit for you.
- Share your finances to get personalised advice and recommendations.
FAQs
Even though banks buy this product through the IMGC, buyers have to bear the cost of the service.
No, while home insurance covers your house against risk, mortgage guarantee is a credit risk mitigating tool that helps banks in case of EMI defaults by buyers.
Not necessarily. While traditional mortgages with a 20% down payment avoid PMI, guarantee products with lower down payments can lead to long-term savings, especially if PMI can be cancelled later.
The application process is similar to traditional mortgages, but eligibility requirements vary by program.
Some programs might have stricter terms, but many offer a path to homeownership with relaxed eligibility and potential benefits like PMI cancellation.
The cost can vary depending on the program, your credit score, loan amount, and loan-to-value ratio. Generally, expect to pay a premium between 0.5% and 1% of the loan amount annually.
The main downsides are the additional cost of the premium and potentially higher interest rates compared to a traditional mortgage with a larger down payment. Additionally, some programs might have restrictions on the type of property you can purchase.
Yes, some alternatives include saving for a larger down payment to avoid PMI or exploring government assistance programs for first-time homebuyers. Who pays for mortgage guarantee products?
Is home insurance the same as mortgage guarantee?
Is a mortgage guarantee product always more expensive than a traditional mortgage?
Are mortgage guarantee products difficult to obtain?
Are there any restrictions on guarantee products?
How much does a mortgage guarantee typically cost?
What are the potential downsides of using a mortgage guarantee product?
Are there any alternatives to mortgage guarantee products?
| Got any questions or point of view on our article? We would love to hear from you. Write to our Editor-in-Chief Jhumur Ghosh at jhumur.ghosh1@housing.com |