Jeffrey Wade
Mortgage insurance is typically required when borrowers make a down payment of less than 20% of the home's value. This insurance protects the lender if the borrower defaults on their loan. There are two main types of mortgage insurance: Private Mortgage Insurance (PMI) and Mortgage Insurance Premium (MIP). PMI is associated with conventional loans and can be removed once the borrower reaches 20% equity in the home. MIP is associated with Federal Housing Administration (FHA) loans and is usually paid for the life of the loan, but there are ways to cancel or refinance to remove it. So, while mortgage insurance may be permanent on some new mortgages, it is not always the case and depends on various factors such as loan type, down payment amount, and equity.
| Characteristics | Values |
|---|---|
| Who does mortgage insurance protect? | The lender, not the borrower |
| When is mortgage insurance required? | When the borrower makes a down payment of less than 20% of the home's value, or when the borrower takes out a Federal Housing Administration (FHA) or U.S. Department of Agriculture (USDA) loan |
| How much does mortgage insurance cost? | Typically 0.5% to 1% of the total loan amount per year, but can range from 0.58% to 1.86% annually |
| How is mortgage insurance paid? | As a monthly premium, or as a one-time upfront payment at closing, or a combination of both |
| Can mortgage insurance be cancelled? | Yes, under certain circumstances. Private mortgage insurance (PMI) can be cancelled when the borrower has paid off 20% of the loan, or has achieved 20% equity in their home. FHA mortgage insurance may be cancelled after 11 years if the borrower puts down at least 10%. |
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What You'll Learn
Private mortgage insurance (PMI)
PMI can be paid in different ways. It is typically paid monthly, included in the borrower's total monthly payment to the lender. Sometimes, it is paid as a one-time upfront premium at closing, or both upfront and monthly. The upfront premium is shown on the Loan Estimate and Closing Disclosure documents. Lenders may offer multiple payment options, and it is recommended to compare the total costs over different timeframes to make an informed decision.
PMI is not permanent and can be cancelled under certain circumstances. Federal law dictates that the mortgage lender must automatically terminate PMI when the loan-to-value (LTV) ratio reaches 78%, or when the borrower passes the midpoint of the loan term. Borrowers can also request to cancel PMI when their mortgage balance reaches 80% of the home's value. To prove this, a professional appraisal or broker's assessment may be required.
There are alternative ways to avoid PMI. One option is to save up for a 20% down payment, which typically exempts borrowers from PMI requirements. Another strategy is to refinance the loan, converting it into a conventional loan without PMI or an FHA loan with lower mortgage insurance premiums. Additionally, certain loans, such as VA-backed loans, do not require PMI, although they may have other associated fees.
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Mortgage insurance premium (MIP)
Mortgage insurance is typically required when borrowers make a down payment of less than 20% of the purchase price of the home. It lowers the risk to the lender if the borrower defaults on the loan. Mortgage insurance premium (MIP) is a type of mortgage insurance that is required for homeowners who take out loans backed by the Federal Housing Administration (FHA). Unlike conventional loans, which usually only require private mortgage insurance (PMI) if the down payment is less than 20% of the purchase price, all FHA loans require MIP.
FHA-backed lenders use MIPs to protect themselves against higher-risk borrowers who are more likely to default on loans. Since FHA loans come with a down payment as low as 3.5% and a credit score as low as 580, default is a key concern. MIP is paid by homeowners who take out loans backed by the FHA, and it includes both an upfront cost and a monthly cost. The upfront cost is typically 1.75% of the total loan amount, and it is paid as part of the closing costs. The monthly cost is included in the monthly mortgage payment.
For FHA loans originated between December 31, 2000, and June 3, 2013, if you have paid off at least 78% of the loan-to-value amount, you may ask the lender to cancel the MIP. However, for loans originated after June 3, 2013, if you made a down payment of less than 10% of the home's value, you must pay the MIP for the life of the loan. The only way to remove MIP on an FHA loan is to refinance it into a non-FHA product.
It is important to note that mortgage insurance premiums were previously tax-deductible, but this is no longer the case. Lenders are required to send Form 1098 Mortgage Interest Statement to both the borrower and the Internal Revenue Service (IRS), which includes the total MIP or PMI premiums.
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Cancelling mortgage insurance
Mortgage insurance is not permanent and can be cancelled under certain conditions. Private mortgage insurance (PMI) is typically required when borrowers make a down payment of less than 20% of the purchase price of the home. It can be paid monthly or as an upfront cost.
There are several ways to cancel PMI:
- Automatic Cancellation: According to the Homeowners Protection Act of 1998 (HPA), your servicer must automatically cancel PMI when your mortgage's loan-to-value (LTV) ratio reaches 78% of the home's purchase price or the month after you reach the midpoint of your loan's amortization schedule (usually after 15 years for a 30-year loan). To be eligible for automatic cancellation, you must be current on your payments.
- Request for Cancellation: You can request to cancel PMI when your loan-to-original-value (LTOV) ratio falls below 80%. This can be achieved by making additional payments to reduce the principal balance or by increasing the value of your home through renovations or market appreciation. If your home's value has increased, you will need to pay for a home appraisal to verify the new market value.
- Refinancing: You can refinance to a conventional loan to eliminate mortgage insurance premiums (MIP) associated with Federal Housing Administration (FHA) loans. Refinancing can be a good option when home values are high, as it may provide the equity needed to refinance and avoid paying PMI.
- Alternative Loan Options: If you are a servicemember, veteran, or family member, you may be eligible for a VA-backed loan, which does not require monthly mortgage insurance premiums. Instead, you pay an upfront "funding fee," which can be rolled into your mortgage.
It is important to note that the ability to cancel PMI may depend on the type of loan and the lender's rules and requirements. Contact your lender or mortgage servicer to understand the specific conditions for cancelling your mortgage insurance.
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How much does mortgage insurance cost?
The cost of mortgage insurance varies depending on the type of loan and the lender.
Private Mortgage Insurance (PMI)
Private mortgage insurance is required for conventional loans where the borrower has made a down payment of less than 20% of the purchase price of the home. The average cost of PMI is about 0.4% to 0.5% of the loan amount per year, although it can range from 0.46% to 1.5%. The PMI rate depends on factors such as the down payment amount, credit score, debt-to-income ratio, and local housing market dynamics. For example, a borrower with a 3% down payment and a credit score below 680 may pay more than 1% of the loan amount annually for PMI, while a borrower with a 15% down payment and an excellent credit score may pay less than 0.5%.
Federal Housing Administration (FHA) Loans
FHA loans require mortgage insurance, known as a Mortgage Insurance Premium (MIP), regardless of the down payment amount. MIP costs the same for all borrowers, with a slight increase for down payments less than 5%. If a borrower takes out an FHA loan with a down payment of at least 10%, they will only pay MIP for 11 years.
U.S. Department of Agriculture (USDA) Loans
USDA loans are similar to FHA loans, but typically cheaper. Borrowers pay for insurance at closing and as part of their monthly payment.
Department of Veterans' Affairs (VA)-backed Loans
VA-backed loans do not require monthly mortgage insurance premiums. However, borrowers pay an upfront "funding fee" that can be rolled into the mortgage, increasing the loan amount and overall costs.
It is important to note that mortgage insurance protects the lender, not the borrower, in case of default on loan payments. While it increases the cost of the loan, it allows borrowers to qualify for loans they might not otherwise be able to obtain.
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Who does mortgage insurance protect?
Mortgage insurance, no matter the type, protects the lender or titleholder—not the borrower—in the event that the borrower falls behind on their payments, passes away, or is otherwise unable to meet the contractual obligations of the mortgage. This means that if a borrower defaults on their payments, the lender will be repaid in full even in the worst-case scenario of the property being sold through foreclosure and the sale not being enough to cover the mortgage balance.
Mortgage insurance is not always required, but lenders generally ask for it when homebuyers' down payments are less than 20% of their new home's purchase price. This is because mortgage insurance decreases a lender's financial risk, allowing borrowers with lower credit scores and less cash for a down payment to qualify for a home loan they may not otherwise be eligible for.
Mortgage insurance can refer to private mortgage insurance (PMI), qualified mortgage insurance premium (MIP) insurance, or mortgage title insurance. Private mortgage insurance is usually paid monthly, with little to no upfront payment, and can be cancelled under certain circumstances. MIP insurance is required for all Federal Housing Administration (FHA) loans and costs the same regardless of credit score, with a slight increase for down payments of less than five percent. With FHA loans, the upfront cost can be rolled into the mortgage, but this increases the loan amount and overall costs.
It is important to distinguish mortgage insurance from mortgage life insurance, which protects the heirs of a borrower in the event that the borrower dies while still owing mortgage payments.
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Frequently asked questions
Mortgage insurance is a type of insurance that protects the lender in case a borrower defaults. It is usually required when the borrower makes a down payment of less than 20% of the home's value.
Mortgage insurance typically costs between 0.5% to 1% of your total loan amount per year. For example, if you have a $250,000 home loan, you can expect to pay between $1,250 to $2,500 per year or between $104 and $208 per month.
You can request to remove PMI when you have achieved 20% equity in your home or have paid your loan balance down below 80% of the purchase price of your home. In some cases, PMI will be removed automatically when your loan balance reaches 78% of the original value.
PMI is associated with conventional loans, while FHA mortgage insurance is associated with loans from the Federal Housing Administration. PMI is typically required when the borrower makes a down payment of less than 20%, while FHA mortgage insurance is required for all FHA loans regardless of the down payment amount.
You can avoid paying for mortgage insurance by making a down payment of 20% or more. Alternatively, you can try to negotiate lender-paid insurance, but this may result in higher interest rates.
