Mortgage insurance basics
Mortgage insurance might sound like something that protects you — the homeowner — should you fall behind on your payments. But in reality, it’s a policy for the lender that ensures they’ll recoup their losses if you stop repaying your loan.
Unfortunately, it’s the homeowner who pays for these policies. There’s usually a monthly fee for mortgage insurance and sometimes an upfront fee, too.
Want to know more about how mortgage insurance works and what it will cost? Mortgage advisor Ivan Simental explains it all in the latest episode of The Mortgage Reports Podcast.
Listen to Ivan on The Mortgage Reports Podcast!
What is mortgage insurance?
Mortgage insurance protects your lender in the event you stop making payments. If your house went into foreclosure, the mortgage insurance you’ve paid would protect your lender from financial losses.
Is mortgage insurance required?
Mortgage insurance is almost always required when you buy a house with less than 20% down. (The exception is if you qualify for a VA loan, which has no monthly mortgage insurance.) This coverage is required on low-down-payment loans because it offsets the risk your lender is taking on with a bigger loan amount.
In some cases, like with FHA loans, mortgage insurance also allows lenders to offer lower interest rates.
Is mortgage insurance bad for buyers?
Mortgage insurance doesn’t just help lenders.
Although it only covers your lender’s financial investment — not your own — mortgage insurance benefits the buyer, too. It lets you purchase a home with less money saved up. And sometimes, as with an FHA loan, mortgage insurance can help you buy a house even with a low credit score.
While you may have heard that mortgage insurance is a waste of money, that’s often not the case. Take the time to learn more about mortgage insurance and how it can help you before you reject the idea.
Types of mortgage insurance
There are two main types of mortgage insurance: PMI (private mortgage insurance) and MIP (mortgage insurance premium).
Here’s how the two measure up:
Private mortgage insurance (PMI)
Private mortgage insurance is only for conventional loans with down payments under 20%. The cost of PMI varies, though Freddie Mac estimates it’s about $30 to $70 per month for each $100,000 borrowed.
If your loan amount is $350,000, for example, PMI is likely to cost between $105 and $245 per month.
One important thing to note about PMI is that it can be removed once your home reaches 80% loan-to-value (LTV) — meaning you’ve built up a 20% equity stake in the home. This will usually happen within a few years as you pay down your mortgage and as property values rise.
Mortgage insurance premium (MIP)
Mortgage insurance premiums are only on FHA loans. Though MIP rates can vary, most borrowers pay 0.85% of their loan amount per year. This is broken into monthly installments and included in your mortgage payment, as with PMI.
FHA also charges an upfront MIP fee equal to 1.75% of the loan amount. You could pay this at closing if you want, but most borrowers roll it into their loan balance to avoid paying upfront.
Unlike PMI, FHA MIP cannot be canceled. Assuming you put down less than 10%, FHA MIP stays on the loan until you finish paying it off or refinance.
Mortgage insurance (MI)
Though less common than PMI or MIP, there’s another type of mortgage insurance charged on USDA loans. Called simply ‘mortgage insurance’ or ‘MI’, the USDA charges both an annual fee and an upfront guarantee fee. These are used to keep the USDA loan program funded, just as FHA MIP is used by the Federal Housing Administration to keep the FHA loan program running.
Do VA loans require mortgage insurance?
The Department of Veterans Affairs does not require mortgage insurance on VA loans. However, it does have a similar fee to help keep the program running.
On VA loans, this is called a funding fee and it ranges from 1.4% to 3.6% of the loan amount. Like the upfront FHA mortgage insurance fee, this can be paid at closing or rolled into the loan balance. Most borrowers choose to roll their VA funding fee into the mortgage.
“The federal government does evaluate these every year, and they can change depending on what the federal government determines is the appropriate fee for that specific year,” Simental says. “So depending on when your loan closed, that’s when your fee will be fixed for the remainder of the life of the loan.”
How to avoid mortgage insurance
If you don’t like the prospect of mortgage insurance, you might be wondering how to avoid it.
There are a few ways to get around mortgage insurance or, at the very least, get rid of it later on down the line. You can:
Make a bigger down payment
Conventional loans don’t require PMI if you make a 20% down payment. This is the easiest way to avoid mortgage insurance costs.
All FHA loans require MIP, but there are ways out of it — at least eventually. To do this, you’d need to make at least a 10% down payment. Then, you can cancel MIP after 11 years in the home.
Build up a 20% equity stake
Once you have 20% equity in your home (meaning your loan balance is only 80% of your home’s value), you can request to cancel your PMI. You’d do this by simply calling your bank or mortgage servicer — the company you send your payments to.
“The call would go something like, ‘Hello bank, I now have enough equity in my property where I would like to remove my private mortgage insurance,’” Simental says. ‘The bank will then say, ‘Alright. Awesome. It looks like you do have enough equity, so we are able to remove that now.’”
In some cases, the bank or servicer may require an appraisal to confirm your home’s value. If this is the case in your situation, you would need to pay for the appraisal out of pocket.
Refinance your loan
The final option would be to refinance your FHA loan into a conventional loan. As long as you have at least 20% equity in the property, you won’t have to pay for PMI on your new loan.
Similarly, if you have a conventional loan and your home has increased in value, you may be able to remove PMI with a refinance. It’s not a necessity, since PMI can be removed without a refi, but refinancing could have the added benefit of lowering your interest rate and bringing down your monthly payment even further.
Consult a mortgage pro
If you’re planning on applying for a mortgage, talk to a mortgage expert about your options. They can help you determine if paying for mortgage insurance will be necessary in your situation or, in some cases, suggest ways to avoid it entirely.