Paul Sanchez
Mortgage insurance is a fee paid to the lender to protect them if the borrower defaults on payments. It is not always required, but it is generally necessary when the down payment is less than 20% of the purchase price. This insurance is included in the monthly payment made to the lender. There are different types of mortgage insurance, including private mortgage insurance (PMI), which is arranged by the lender and issued by private insurance companies. Some loans, such as VA loans, do not require mortgage insurance but may have other fees.
| Characteristics | Values |
|---|---|
| Who does mortgage insurance protect? | The lender, not the borrower. |
| Who needs mortgage insurance? | Borrowers who make a down payment of less than 20% of the purchase price of the home. |
| What is the purpose of mortgage insurance? | To lower the risk to the lender of making a loan to the borrower. |
| What are the consequences of mortgage insurance for the borrower? | It increases the cost of the loan. |
| What are the types of mortgage insurance? | Private mortgage insurance (PMI), mortgage title insurance, Federal Housing Administration (FHA) insurance, U.S. Department of Agriculture (USDA) guarantee fee, and VA funding fee. |
| How much does mortgage insurance cost? | The cost varies by down payment amount and credit score. |
| How is mortgage insurance paid? | Typically, mortgage insurance is paid monthly, but it can also be paid as a lump sum at the time of mortgage origination. |
| Can mortgage insurance be avoided? | Yes, by making a down payment of at least 20%. |
| Are there alternatives to mortgage insurance? | Yes, some lenders offer a ""piggyback" second mortgage or a low down payment mortgage that doesn't require mortgage insurance. |
| Can mortgage insurance be cancelled? | Yes, under certain circumstances, mortgage insurance can be cancelled. For example, PMI can be cancelled once the borrower has over 20% equity in their home. |
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What You'll Learn
Private mortgage insurance (PMI)
PMI can be paid with a one-time upfront premium, with both upfront and monthly premiums, or solely with monthly payments. The upfront premium is shown on the Loan Estimate and Closing Disclosure, while the monthly premium is shown in the Projected Payments section. Lenders may offer multiple PMI options, and borrowers should ask for detailed pricing for different options to make an informed decision.
Borrowers can request to cancel PMI when their mortgage balance reaches 80% of their home's value. Federal law dictates that lenders must automatically end PMI when the loan-to-value (LTV) ratio drops to 78% or when the borrower passes the midpoint of their loan term. To prove that PMI cancellation conditions have been met, borrowers may need to get their home reappraised by a professional appraiser or broker.
Some alternatives to PMI exist. Special programs through local governments or certain lenders may offer low down payment mortgages that do not require PMI. Additionally, lenders may offer a "piggyback" second mortgage marketed as a cheaper alternative. However, borrowers should always compare the total costs before choosing an option.
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Federal Housing Administration (FHA) loans
FHA loans require mortgage insurance, with the premium payments going to the FHA. Borrowers must pay two types of mortgage insurance premiums (MIPs)—one upfront and the other monthly. FHA mortgage insurance is required for all FHA loans. It costs the same regardless of your credit score, with a slight increase in price for down payments of less than five percent. The upfront cost is paid as part of the closing costs, while the monthly cost is included in the monthly payment. Borrowers who can afford a substantial down payment may be better off with a conventional mortgage to avoid the monthly mortgage insurance payments for the FHA loan.
Mortgage insurance protects the lender in the event that the borrower falls behind on their payments. It also lowers the risk to the lender of making a loan to the borrower, allowing them to qualify for a loan they might not otherwise be able to get. However, it increases the cost of the loan. If the borrower falls behind on their payments, their credit score could suffer, and they may lose their home through foreclosure.
FHA loans feature minimum down payments as low as 3.5% and have easier credit qualifications than conventional loans. Before approving an FHA loan, lenders will ask for evidence of recent and steady employment, documented by tax returns and pay stubs. They will also assess whether the mortgage payments, property taxes, mortgage insurance, and homeowners insurance premiums, and any homeowner association fees will total less than 31% of the borrower's gross income.
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U.S. Department of Agriculture (USDA) loans
USDA loans are a type of mortgage loan backed by the U.S. Department of Agriculture under its Rural Development program. They are designed for low- to moderate-income home buyers in areas deemed rural by the USDA. The program aims to make homeownership more accessible by eliminating the down payment requirement, offering lower mortgage insurance rates, and providing interest rates below the market due to government subsidies.
USDA loans do not require traditional mortgage insurance, which protects the lender if the borrower defaults on the loan. However, they do include two guarantee fees that serve a similar purpose and fund the program. The first is an upfront guarantee fee, typically amounting to 1% of the loan value, which can be paid at closing or rolled into the total loan amount. The second is an annual guarantee fee of 0.35% of the outstanding loan balance, divided into monthly installments and included in the monthly mortgage payment.
USDA loans offer attractive terms for rural homebuyers, including the absence of a down payment requirement and flexible credit score criteria. Most lenders accept credit scores as low as 640, whereas conventional loans usually require a minimum score of 620. Additionally, USDA loans are available as 30-year fixed-rate mortgages, with the option to extend the term up to 38 years to make payments more manageable.
To qualify for a USDA loan, borrowers must meet certain income limits and purchase a home in an eligible rural area. The home must be the primary residence, and the borrower's income must fall under the USDA limits. The USDA loan program does not allow cash-out refinancing, and there is no set loan limit, as the amount borrowed is determined by the borrower's income and repayment ability.
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Department of Veterans' Affairs (VA) loans
Department of Veterans Affairs (VA) loans are backed by the Department of Veterans Affairs and are available to veterans, service members, and their surviving spouses. VA loans are obtained through private lenders, such as banks and mortgage companies, and the VA guarantees a portion of the loan, enabling the lender to provide more favourable terms.
VA loans do not require a down payment or mortgage insurance, which is a significant benefit to veterans and service members. Instead of mortgage insurance, VA loans have a
VA loans offer competitive interest rates, flexible credit guidelines, and the industry's lowest average fixed interest rates. They can be used to purchase a single-family home, condominium, multi-unit property, manufactured house, or new construction.
In addition to purchase loans, the VA also offers cash-out refinance loans, interest rate reduction refinance loans, and adapted housing grants for veterans with permanent and total service-connected disabilities. The VA's mission is to help service members, veterans, and their families become homeowners through various loan and housing programs.
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Alternatives to mortgage insurance
Private mortgage insurance (PMI) is an extra expense for conventional mortgage borrowers who make a down payment of less than 20%. While PMI is not permanent, it can be costly, and there are alternatives to paying it.
One option is to take out a second mortgage, also known as a piggyback loan. This involves obtaining a first mortgage for 80% of the home's value, thus avoiding PMI, and then taking out a second mortgage for the remaining amount. For example, if you are buying a home for $300,000, you would take out the first mortgage for $240,000, make a $30,000 down payment, and get a second mortgage for the remaining $30,000.
Another alternative is lender-paid PMI, where the lender pays the premiums, but you pay a higher interest rate on the loan. This option may cost more in the long run, and it can be difficult to get out of lender-paid PMI.
If you are a qualified veteran or servicemember, you may be eligible for a VA home loan, which does not require mortgage insurance or a down payment.
Additionally, you can try to improve your credit score, as a higher credit score can lead to a lower PMI cost.
Finally, it is important to carefully review the mortgage application and understand the details. Mortgage life insurance, for example, has been criticised for only benefiting the lender and not providing any benefits to the borrower's heirs.
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Frequently asked questions
No, not all mortgages require mortgage insurance. The need for mortgage insurance depends on factors such as the type of mortgage and the size of the down payment.
Mortgage insurance is a fee paid to the lender to cover the risks associated with funding a loan. It protects the lender in case the borrower defaults on the loan.
You can avoid paying for mortgage insurance by making a down payment of 20% or more. Some loan programs, such as VA loans, also do not require mortgage insurance.
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