Alyssa Lane
Mortgage insurance, also known as mortgage guarantee or home-loan insurance, is an insurance policy that compensates lenders or investors in mortgage-backed securities for losses due to the default of a mortgage loan. It is typically required when the down payment or equity position is less than 20% of the property value. Mortgage insurance can be either public or private, with the private type being the most common in today's lending marketplace. Private mortgage insurance (PMI) rates vary by down payment amount and credit score but are generally cheaper for borrowers with good credit. Mortgage insurance is an additional layer of protection for the lender and does not protect the borrower.
| Characteristics | Values |
|---|---|
| Who does it protect? | Lenders or investors in mortgage-backed securities |
| Who does it not protect? | The borrower |
| Who provides it? | Private companies or public bodies |
| When is it required? | When the down payment is less than 20% of the property value |
| What does it cost? | Between 0.5% and 1.5% of the original loan amount each year |
| How is it paid? | Monthly, annually, in a lump sum, or a combination |
| Can it be cancelled? | Yes, once the loan-to-value ratio is 80% or lower |
| Are there alternatives? | Yes, a "piggyback" second mortgage or a VA-backed loan |
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What You'll Learn
Private mortgage insurance (PMI)
PMI rates vary depending on factors such as the loan amount, down payment size, interest rate structure, and credit score. For those with a credit score of 620 to 639, PMI can be as high as 1.5% of the loan amount, while those with a score of 760 or higher might pay as low as 0.46%. Generally, PMI is cheaper for borrowers with good credit scores.
PMI can be cancelled under certain circumstances, such as when the borrower has paid off a certain proportion of their loan. The US Homeowners Protection Act of 1998 allows borrowers to request PMI cancellation when the amount owed is reduced to 80% of the loan-to-value (LTV) ratio. Federal law also dictates that lenders must automatically end PMI when the LTV ratio drops to 78% or when the borrower passes the midpoint of their loan term.
While PMI increases the cost of a loan, it also lowers the risk to the lender, allowing them to extend credit to high-risk buyers. This, in turn, helps borrowers qualify for loans they might not otherwise be able to obtain. However, it is important to note that PMI protects the lender and not the borrower. If a borrower falls behind on their payments, they will not receive any insurance benefit, and they can still lose their home through foreclosure.
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Federal Housing Administration (FHA) loans
Mortgage insurance, also known as mortgage guarantee and home-loan insurance, is an insurance policy that protects lenders or investors in mortgage-backed securities in the event of a borrower defaulting on their mortgage loan. It is typically required when the down payment is less than 20% of the property value.
The Federal Housing Administration (FHA) provides mortgage insurance on single-family, multifamily, manufactured home, and hospital loans made by FHA-approved lenders. FHA loans are government-insured mortgages issued by FHA-approved lenders, such as banks. These loans are designed to help low- to moderate-income families attain homeownership, particularly first-time homebuyers, and are available to everyone. FHA loans require a lower minimum down payment and allow for lower credit scores compared to conventional loans.
To qualify for an FHA loan, lenders will assess the borrower's ability to repay the loan. This includes evaluating recent and steady employment, tax returns, pay stubs, and income history. The total mortgage payments, including property taxes, mortgage insurance, homeowners insurance, and any homeowner association fees, should generally not exceed 31% of the borrower's gross income (known as the front-end ratio). Additionally, the back-end ratio, which includes all monthly consumer debts, should be less than 43% of the gross income.
FHA borrowers are required to pay two types of mortgage insurance premiums (MIPs): an upfront cost paid during closing and a monthly cost included in the monthly payment. FHA mortgage insurance rates are slightly higher for down payments less than five percent, and they do not vary based on credit scores.
FHA loans offer a path to homeownership for individuals who might be rejected by banks due to their credit score or down payment capabilities. By providing mortgage insurance, the FHA reduces the risk to lenders and makes it easier for borrowers to qualify for home loans.
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Lender-paid mortgage insurance (LPMI)
Mortgage insurance, also known as mortgage guarantee or home-loan insurance, is an insurance policy that compensates lenders or investors in mortgage-backed securities for losses due to the default of a mortgage loan. It is typically required when the borrower makes a down payment of less than 20% of the purchase price of the home. This insurance lowers the risk to the lender of issuing a loan, allowing borrowers who may not otherwise qualify to obtain financing. However, it increases the overall cost of the loan for the borrower.
One of the main advantages of LPMI is that it can make homeownership more accessible to those who may not have the funds for a 20% down payment. It eliminates the need for a separate mortgage insurance payment, which can improve cash flow for the borrower. Additionally, LPMI may be a better option for those who do not plan to stay in their homes for an extended period or anticipate refinancing their loan in the future.
However, it is crucial to recognize the potential drawbacks of LPMI. Firstly, the higher interest rate associated with LPMI can result in paying more over the life of the loan compared to BPMI. This is because the borrower is stuck with the higher interest rate for the entire loan term, whereas BPMI can be cancelled once the borrower reaches 20% equity in the home. Therefore, LPMI may be more costly in the long run, especially for those who plan to stay in their homes for a longer duration. Additionally, LPMI cannot be cancelled, even if the borrower's financial situation improves and they are able to make larger payments towards the principal.
When deciding between LPMI and other options, it is essential to carefully consider your financial situation, how long you plan to stay in the home, and the potential impact on your overall costs. Comparing different lenders and seeking advice from a mortgage broker or loan officer can help determine the most suitable choice for your specific circumstances.
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Borrower-paid mortgage insurance (BPMI)
With BPMI, the lender will typically add the cost of the PMI to the borrower's monthly payment. The borrower will make that additional payment until they achieve 20% equity in their home. BPMI single premium options may be a good choice for a borrower who wants to keep the monthly payment low. The BPMI single option allows homebuyers or other parties (e.g. sellers or builders) to pay the full premium upfront at closing or to finance it into the loan. The BPMI single option is available as refundable or non-refundable. For homebuyers with the refundable BPMI version, a partial refund may occur depending on the amount of time the MI coverage was in place. Homebuyers with the non-refundable option could also receive a partial refund if it is canceled under the US Homeowners Protection Act of 1998 (HPA). This Act allows for borrowers to request PMI cancellation when the amount owed is reduced to 80% LTV.
There is a growing trend for BPMI to be used with the Fannie Mae 3% down payment program. In some cases, the lender gives the borrower a credit to cover the cost of BPMI. BPMI can be cancelled under certain circumstances, such as when the borrower has achieved 20% equity in their home. However, it typically takes 11 years to build enough equity to cancel a borrower-paid mortgage insurance policy.
BPMI rates can range from 0.14% to 2.24% of the principal balance per year, depending on the percent of the loan insured, LTV, interest rate structure, and credit score. PMI payments are heavily based on credit score. For example, a buyer with a credit score of 640 will pay more than $300 per month with a 5% down loan at an average home price. The same borrower with a credit score of 740 would pay just over $100 per month. BPMI is generally cheaper than Federal Housing Administration (FHA) rates for borrowers with good credit.
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Mortgage insurance alternatives
Mortgage insurance, also known as mortgage guarantee or home-loan insurance, is an insurance policy that compensates lenders or investors in mortgage-backed securities for losses due to defaults on mortgage loans. It is not the same as mortgage protection insurance, which pays out a lump sum to cover your mortgage if you die within the term of the policy, or if you lose your job through no fault of your own.
- Lender-paid mortgage insurance (LPMI): With LPMI, the lender covers your premium, but you'll pay a higher interest rate on your mortgage in exchange. Unlike BPMI, you won't be able to cancel your premium when your home equity reaches 20%continue to pay the same elevated interest rate until your loan is paid off.
- Split-premium mortgage insurance: This type of insurance divides your premium into two parts. You'll pay a portion upfront, typically at closing. The balance is paid over time with your monthly mortgage payments. With split-premium mortgage insurance, you can reduce both your monthly payments and the amount of cash you'll need to have on hand at closing. It may be a good option if you have a high debt-to-income ratio (DTI).
- Mortgage payment protection insurance (MPPI): MPPI is a type of income protection. You can claim it if you lose your job through no fault of your own, cannot work due to serious injury or illness, or become unemployed. It will cover your monthly mortgage repayments, as long as they don't exceed 65% of your monthly gross salary.
- Piggyback second mortgage: Some lenders may offer a "piggyback" second mortgage as an alternative to mortgage insurance. This option may be marketed as cheaper, but it's important to compare the total cost before deciding.
- Building savings and investments: Instead of making premium payments over years, you can save and invest your money so it grows. If you have enough, it can be sufficient to pass on to your loved ones when you die, so they can either make the payments or pay off the loan.
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Frequently asked questions
Mortgage insurance, also known as mortgage guarantee or home-loan insurance, is an insurance policy that protects lenders or investors in mortgage-backed securities from losses due to the default of a mortgage loan. It is typically required when the down payment is less than 20% of the property value.
There are several types of mortgage insurance, including:
- Borrower-paid mortgage insurance (BPMI)
- Lender-paid mortgage insurance (LPMI)
- Single-premium mortgage insurance
- Private mortgage insurance (PMI)
- Qualified mortgage insurance premium (MIP) insurance
- Mortgage title insurance
Mortgage insurance is typically paid monthly, along with your regular mortgage payment. The cost of mortgage insurance varies depending on your loan type, but it generally ranges from 1% to 3% of your home's purchase price. Mortgage insurance can be cancelled once the loan balance reaches a certain threshold, typically 80% of the original value of the home.
