Alyssa Lane
Mortgage insurance is a policy that compensates the lender in the event that the borrower defaults on their mortgage. It is usually required when the borrower makes a down payment of less than 20% of the purchase price of the home. The insurance lowers the risk to the lender of making a loan to the borrower, allowing them to qualify for a loan that they might not otherwise be able to get. Mortgage insurance is typically required for Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans, and it can be included in the total monthly payment made to the lender or the costs at closing.
| Characteristics | Values |
|---|---|
| Who does mortgage insurance protect? | The lender |
| Who pays for mortgage insurance? | The borrower |
| When is mortgage insurance required? | When the down payment is less than 20% |
| How much does mortgage insurance cost? | Between 0.1% to 2% of the loan balance per year |
| How is mortgage insurance paid? | Monthly, upfront, or split |
| Can mortgage insurance be cancelled? | Yes, once the borrower has over 20% equity in their home |
| What is Private Mortgage Insurance (PMI)? | A type of mortgage insurance required for conventional loans |
| What is Mortgage Insurance Premium (MIP)? | A type of mortgage insurance required for Federal Housing Administration (FHA) loans |
| Are there alternatives to mortgage insurance? | Yes, some lenders may offer a "piggyback" second mortgage |
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What You'll Learn
Private mortgage insurance (PMI)
PMI is required for Federal Housing Administration (FHA) loans and U.S. Department of Agriculture (USDA) loans. It is also required when refinancing a conventional loan where your equity is less than 20% of the value of your home. PMI rates vary by down payment amount and credit score but are generally cheaper than FHA rates for borrowers with good credit.
You can pay PMI in several ways:
- Borrower-paid monthly: The borrower pays the insurance monthly, typically as part of their mortgage payment.
- Borrower-paid single premium: You make one PMI payment upfront or roll it into the mortgage.
- Split premium: The borrower pays part upfront and part monthly.
- Lender-paid: The borrower pays indirectly through a higher interest rate or higher mortgage origination fee.
PMI does not protect you if you fall behind on your mortgage payments, and you can still lose your home through foreclosure. Lenders are required to cancel PMI when your mortgage balance reaches 78% to 80% of your home's value, or once you are halfway through your loan term, whichever comes first.
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Mortgage insurance premium (MIP)
MIP is distinct from private mortgage insurance (PMI), which is typically required for conventional loans with a down payment of less than 20%. In contrast, MIP is required for all FHA loans, even if the down payment is above 20%. The upfront MIP for an FHA loan is typically 1.75% of the total loan amount, paid at closing. Additionally, there is a monthly MIP, which is included in the borrower's monthly payment. The annual MIP rate varies depending on factors such as the down payment, loan amount, and loan term, ranging from 0.15% to 0.75% of the average outstanding loan balance.
The duration of MIP payments depends on the loan's origination date and the down payment. For FHA loans originated between December 31, 2000, and June 3, 2013, borrowers may request the lender to cancel the MIP after paying off at least 78% of the loan-to-value amount. For loans originated after June 3, 2013, if the down payment is less than 10%, the borrower must pay MIP for the life of the loan. If the down payment is more than 10%, the MIP is paid for 11 years.
It is important to note that MIP is non-refundable. Once the loan balance drops below 78%, borrowers can request to have the MIP removed, but they will not receive a refund for the premiums already paid. Additionally, unlike PMI, where borrowers can choose from different types (borrower-paid monthly, borrower-paid single premium, split premium, or lender-paid), there is only one type of MIP, and the borrower always pays the premiums.
MIP provides protection for lenders in the event of borrower default. By paying MIP, borrowers can access competitive interest rates and qualify for loans with lower down payment requirements. However, it increases the overall cost of the loan.
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Federal Housing Administration (FHA) loans
When taking out an FHA loan, borrowers are required to purchase two types of mortgage insurance premiums (MIPs): an upfront premium and a monthly premium. The upfront premium is typically 1.75% of the loan amount, paid as part of the closing costs, while the monthly premium is included in the borrower's monthly payments. FHA loans also tend to have lower interest rates than conventional loans, making them an attractive option for those with limited cash available for a down payment.
It is important to note that mortgage insurance protects the lender, not the borrower, in the event of default on the mortgage. In the case of foreclosure, the insurance company covers part of the lender's loss. Once the borrower has paid off a significant portion of the loan, they may be eligible to cancel the mortgage insurance, thus reducing their monthly costs.
FHA loans are available to everyone, even those who can afford conventional mortgages. However, borrowers with substantial down payments may find it more advantageous to opt for a conventional mortgage to avoid the additional costs of mortgage insurance associated with FHA loans. Ultimately, borrowers should carefully consider their financial situation and seek out the loan option that best suits their needs.
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U.S. Department of Agriculture (USDA) loans
USDA loans are a type of mortgage geared toward lower-income home buyers in areas deemed rural or suburban by the U.S. Department of Agriculture, the agency that guarantees these loans. The USDA loan program is designed for people who want to live outside urban areas. It often comes with zero down payment, low interest rates, and more flexible credit requirements.
USDA loans do not require private mortgage insurance (PMI) as PMI only applies to conventional loans. However, USDA loans do have two types of fees that function similarly to PMI: an upfront guarantee fee, which equals 1% of the total loan amount, and an annual fee, which equals 0.35% of the loan amount. These fees are levied no matter if you pay 0% down or 20% down. The upfront fee is paid at closing and is rolled into the loan amount, while the annual fee is calculated once per year and then divided into monthly payments along with other monthly costs. These fees are typically lower than PMI attached to a conventional loan.
USDA loans are comparable to VA loans in that these mortgages typically offer lower interest rates than other loan programs, such as conventional or FHA loans. When a government agency backs a loan, such as a USDA loan or an FHA loan, they essentially provide insurance to the lender. If the borrower defaults on a government-backed loan, that agency pays the lender to help them recoup their losses.
To qualify for a USDA loan, you’ll need to meet a few key requirements: The home must be in a USDA-eligible rural or suburban area, your household income must fall within the USDA’s income limits for your area, the home must be your primary residence, and you must be a U.S. citizen, U.S. national, or qualified alien.
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Cancelling mortgage insurance
Mortgage insurance is a way for lenders to take on more risky loans. It protects them in case the borrower defaults on payments. The cost and other details vary by the type of loan. Typically, borrowers making a down payment of less than 20% of the purchase price of the home need to pay for mortgage insurance.
If you have a Federal Housing Administration (FHA) loan, you will have to pay a mortgage insurance premium (MIP) for either 11 years or the entire length of the loan, depending on the terms of the loan. If you put down more than 10%, you pay MIP for 11 years. The annual premium ranges from 0.15% to 0.75% of the average outstanding loan balance. The upfront premium is 1.75% of the loan amount and is due when the mortgage closes.
If you have a conventional loan, you will have to pay private mortgage insurance (PMI). The rates vary by down payment amount and credit score but are generally cheaper than FHA rates for borrowers with good credit. Most private mortgage insurance is paid monthly, with little or no initial payment required at closing.
You can take steps to get rid of PMI or MIP sooner. If your loan has met certain conditions and your loan-to-original-value (LTOV) ratio falls below 80%, you may submit a written request to have your mortgage servicer cancel your PMI. If your home's value increases, you might be eligible to request a PMI cancellation. You'll need to pay for a home appraisal to verify the new market value.
The Homeowners Protection Act of 1998 (HPA) requires that mortgage lenders or servicers automatically cancel PMI when the mortgage's loan-to-value (LTV) ratio reaches 78% of the home's purchase price, or the month after you reach the loan term's midpoint. For your PMI to be cancelled on that date, you need to be current on your payments.
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Frequently asked questions
Mortgage insurance lowers the risk to the lender of making a loan to you, so you can qualify for a loan that you might not otherwise be able to get. Mortgage insurance also protects the lender in case you fall behind on your payments.
Mortgage insurance is typically required when the down payment on a home is less than 20%. It is also required on Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans.
You can get rid of mortgage insurance by building up equity in your home. Once you reach a certain threshold, typically 20-22% equity, you may be able to cancel your mortgage insurance. For FHA loans, mortgage insurance may be required for the full term unless you refinance to a conventional mortgage.
