In most cases, the process of buying a home involves taking out a mortgage loan and making a down payment. However, if your down payment is less than 20 percent of your home’s purchase price or you are taking out a particular mortgage (such as an FHA loan), you may also need to buy mortgage insurance. For lenders, these are higher-risk lending situations, so they require mortgage insurance to protect their interests.
Below, we’ll explain the basics of mortgage insurance, including what it covers and who needs it.
What is mortgage insurance?
Mortgage insurance is an insurance policy that protects the mortgage lender and is paid for by the borrower of the loan.
You might be wondering: what does mortgage insurance cover? Usually, when you purchase an insurance plan, it is to provide coverage for you. Mortgage insurance, however, provides coverage for your lender.
With mortgage insurance, the lender or titleholder is covered in case you are unable to pay back the mortgage for any reason. This can include defaulting on payments, failing to meet contractual obligations, passing away or any other number of situations that prevent the mortgage from being completely repaid.
How mortgage insurance works
Now that we’ve covered the definition of mortgage insurance, let’s answer another popular question: How does mortgage insurance work?
In general, you need to pay for mortgage insurance if you put down less than 20 percent on a home purchase. This is because you have less invested in the home upfront, so the lender has taken on more risk giving you a mortgage. How much you’ll pay depends on the type of loan you have and other factors.
Even with mortgage insurance, you are still responsible for the loan, and if you fall behind on or stop making payments, you could lose your home to foreclosure.
Types of mortgage insurance and other fees
The type of mortgage insurance that you’ll need depends on several factors, including the kind of loan that you have. Since mortgage insurance is meant to protect lenders, your lender is responsible for choosing the company that provides your mortgage insurance.
Here’s how these types of mortgage insurance differ, including when they’re paid and how much they cost.
Private mortgage insurance
PMI, or private mortgage insurance, is typically required if you’re obtaining a conventional loan with less than 20 percent down. This can include a 3-percent or 5-percent conventional loan or other type of low-down payment mortgage. Most borrowers pay PMI with their monthly mortgage payment. The cost can vary based on your credit score, loan-to-value (LTV) ratio and other factors.
Mortgage insurance premium
MIP is the mortgage insurance premium required for an FHA loan with less than 20 percent down. You’ll pay for this mortgage insurance upfront at closing, and also annually. The upfront MIP equals 1.75 percent of your mortgage, while the annual MIP ranges from 0.45 percent to 1.05 percent of your mortgage based on the amount you borrowed, LTV ratio and the length of the loan term.
USDA guarantee fee
The USDA guarantee fee is one of the costs you’ll pay to obtain a USDA loan, which is available to borrowers in designated rural areas and has no down payment requirement. The guarantee fee is paid upfront and annually, with the upfront fee equal to 1 percent of the loan and the annual fee equal to 0.35 percent.
VA funding fee
VA loans also have no down payment requirement, but are available exclusively to servicemembers, veterans and surviving spouses. While there is no mortgage insurance required for these loans, there is a funding fee that ranges from 1.4 percent to 3.6 percent of the loan, depending on whether you’re making a down payment (and the size of it, if so) and if this is your first time obtaining a VA loan. This funding fee doesn’t have to be paid in some circumstances.
How much does mortgage insurance cost?
As we’ve covered, your mortgage insurance premium will depend on your loan amount, your LTV ratio and other variables. However, the higher your down payment, the lower your mortgage insurance premium will be.
With PMI, you can expect to pay 0.58 percent to 1.86 percent of the original amount of your loan. That equates to $58 to $186 per month for every $100,000 borrowed.
If you have an FHA loan, your upfront premium is 1.75 percent of your loan amount, while your annual premium ranges between 0.45 percent and 1.05 percent. For a $200,000 loan, your upfront MIP premium would be $3,500, and your annual premium would fall between $900 and $2,000 (paid monthly with your mortgage).
USDA loans come with a 1 percent upfront guarantee fee, as well as an annual fee that’s equal to 0.35 percent of your loan amount. Using the $200,000 loan example, that would come out to $2,000 upfront and $700 annually.
For VA loans, the funding fee will range from 1.4 percent to 3.6 percent, depending on the amount of your down payment and whether or not you’ve taken out a VA loan before. That comes out to $2,800 to $7,200 for a $200,000 loan.
Benefits of mortgage insurance
While mortgage insurance primarily benefits the lender, it does serve a purpose for the borrower because it allows you to get a mortgage with limited down payment savings. Putting down 20 percent can be challenging, especially with home values on the rise, so by paying for mortgage insurance, you can still get a loan without needing a large down payment.
By choosing a mortgage that requires mortgage insurance, you can become a homeowner sooner and at a lower upfront cost. Plus, it allows you to consider homes in other neighborhoods that might not have been in your price range.
Waiting until you have a 20 percent down payment also runs the risk of missing out on favorable mortgage rates. Mortgage insurance offers the ability to get those rates now, meaning you can save on interest over time, despite borrowing more money with a smaller down payment at first.
However, there are downsides to mortgage insurance, as well, mainly that it’s an extra expense you wouldn’t otherwise have to pay, and that it can be difficult to get out of if you have an FHA loan.
How to get rid of mortgage insurance
There are downsides to mortgage insurance as well. The biggest minus is that it’s an extra expense you wouldn’t otherwise have to pay. It can also be difficult to get out of if you have an FHA loan without refinance. If you’re concerned, there are a few options to get rid of your mortgage insurance.
If you have a conventional loan, you can get rid of mortgage insurance simply by paying down your loan. Under the Homeowners Protection Act, lenders are required to cancel your mortgage insurance once your balance reaches 78 percent of the original purchase price or once you reach the halfway point of your amortization schedule (so after 15 years of a 30-year mortgage, for example).
You can also request cancellation before the automatic removal once your balance reaches 80 percent of the original value. Some lenders are receptive to this if you are in good standing with your payments.
For FHA loans, the cancelation guidelines depend on your loan origination date. However, for loans that originate after June 3, 2013, you can’t cancel your mortgage insurance until your mortgage is paid in full – unless you made a down payment of 10 percent or more. In that case, your MIP will end after 11 years.
Lastly, you can try to refinance your mortgage in order to get out of the mortgage insurance, or get your home reappraised to see if it has gained value and the LTV ratio improves. In general, these strategies can work if your home has appreciated significantly since you first took out your mortgage.
When you’re buying a home with a down payment under 20 percent, your lender may require mortgage insurance to protect their financial interests in case you can’t pay back your loan.
Although it may seem like just another hoop to jump through on your journey to homeownership, there are some upsides to choosing a mortgage that requires it. Notably, paying for your property with a combination of a down payment and mortgage insurance makes it easier to become a homeowner – even if you can’t afford to pay 20 percent upfront.
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