Mortgage Insurance: What Home Buyers Need To Know

Mortgage insurance is an insurance policy that protects the lender in the event that the borrower defaults on their payments. The borrower is responsible for paying for the insurance, which is typically included in their monthly mortgage payments. This type of insurance lowers the risk to the lender of making a loan, allowing borrowers to qualify for loans they might not otherwise be able to get. However, it increases the overall cost of the loan for the borrower.

Private Mortgage Insurance (PMI)

PMI is arranged by the lender and provided by private insurance companies. It insures the lender against loss caused by borrowers failing to make loan payments. If you fall behind on your mortgage payments, PMI does not protect you, and you can still lose your home through foreclosure.

PMI can help you qualify for a loan that you might not otherwise be able to get. But it can increase the cost of your loan. The most common way to pay for PMI is through a monthly premium, which is added to your mortgage payment. Sometimes, you may pay for PMI with a one-time upfront premium paid at closing, or through a combination of upfront and monthly payments.

Borrowers making a low down payment might want to consider other types of loans, such as an FHA loan. Other types of loans may be more or less expensive than a conventional loan with PMI, depending on your credit score, your down payment amount, the lender, and general market conditions.

You might consider saving up to make a 20% down payment. When you pay 20% down, PMI is not required with a conventional loan, and you could also receive a lower interest rate.

Mortgage Insurance Premium (MIP)

Mortgage insurance is an insurance policy that protects the lender in the event that the borrower defaults on payments, passes away, or is otherwise unable to meet the contractual obligations of the mortgage.

MIP is not to be confused with Private Mortgage Insurance (PMI), which is required on conventional loans with a down payment of less than 20%. PMI is provided by private insurance companies and can be cancelled once the borrower has over 20% equity in their home.

When mortgage insurance is required

Mortgage insurance is usually required when a borrower makes a down payment of less than 20% of the purchase price of the home. It is also typically required for Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans.

Mortgage insurance protects the lender, not the borrower, in the event that the borrower falls behind on their payments. It 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. However, it increases the cost of the loan.

There are several types of mortgage insurance, depending on the type of loan:

• Private Mortgage Insurance (PMI): Required for conventional mortgage borrowers who put down between 3% and 19.99% of the purchase price. It is usually paid monthly and bundled with the borrower's mortgage payment.
• Mortgage Insurance Premium (MIP): Required for borrowers who get a loan backed by the Federal Housing Administration (FHA). It includes an upfront cost, paid as part of the closing costs, and a monthly cost included in the monthly payment.
• Guarantee Fee: USDA-backed mortgages have a similar requirement to FHA loans but refer to the cost as a guarantee fee.
• VA Funding Fees: Department of Veterans Affairs (VA)-backed home loans do not require mortgage insurance, but borrowers may have to pay funding fees.

It is important to note that mortgage insurance should not be confused with homeowners insurance, which protects the homeowner in case of damage to the property or belongings.

How mortgage insurance is calculated

Mortgage insurance is calculated based on several factors, including the size of the loan, the down payment amount, debt-to-income ratio, credit score, repayment terms, and the value of the house. The larger the down payment, the lower the mortgage insurance cost. Those with higher credit scores and lower debt-to-income ratios typically pay lower rates as well.

The average cost of private mortgage insurance (PMI) for a conventional home loan ranges from 0.46% to 1.50% of the original loan amount per year. However, this can vary depending on credit score and other factors. For example, borrowers with lower credit scores pay more for PMI than those with higher credit scores.

To calculate PMI, the following steps can be taken:

• Identify the property value, which can be obtained from a recent appraisal or estimated based on the planned offer for the house.
• Find the total loan amount by subtracting the down payment from the home price.
• Calculate the loan-to-value (LTV) ratio by dividing the loan amount by the property value and multiplying by 100 to get a percentage. If the LTV is 80% or lower, PMI is not required.
• Estimate the annual PMI premium by multiplying the PMI percentage provided by the lender by the total loan amount. If the PMI percentage is unknown, it can be estimated using a range of 0.22% to 2.25%.
• To estimate the monthly PMI cost, divide the annual premium by 12.

It is important to note that PMI rates may vary among lenders and mortgage types, and it is always recommended to consult with a lender or financial advisor for specific calculations.

Pros and cons of mortgage insurance

Mortgage insurance, also known as private mortgage insurance (PMI), is a type of insurance that protects the lender in case the borrower defaults on their mortgage and the home goes into foreclosure. While it is not a requirement for all types of mortgages, PMI is typically needed for conventional mortgages when the borrower makes a low down payment (less than 20%).

Pros:

• Take Advantage of Rising Home Values: With PMI, buyers can purchase a home without having to save for a 20% down payment, allowing them to take advantage of increasing equity growth.
• Lock in Low-Interest Rates: Taking on PMI costs can help buyers save money by allowing them to take advantage of low-interest rates, which may increase if they wait until they have a 20% down payment.
• Consolidate High-Interest Debts: PMI gives buyers the opportunity to make a lower down payment and apply their savings towards other high-interest debts, such as student loans.

Cons:

• Can Be Costly: PMI can range from 0.2% to 2% of the loan amount annually, which can translate to a significant additional cost for the borrower.
• Difficult to Cancel: Removing PMI from a mortgage can be challenging and may require submitting official requests and appraisals. Even if the borrower reaches 20% equity in the home, PMI may not be automatically removed.
• No Direct Benefit to the Borrower: Unlike other types of insurance, PMI does not provide any direct benefit or protection to the borrower, only to the lender.

It is important to note that mortgage life insurance, which pays off the remaining mortgage in the event of the borrower's death, is different from PMI and is not required by lenders. While it can provide peace of mind and protect dependents, it has its own set of pros and cons, including constant premium payments and benefits paid directly to the lender instead of dependents.

Frequently asked questions