Haris Ashley
Mortgage insurance is an insurance policy that protects the lender in case the borrower defaults on their loan. It is usually required when the borrower makes a down payment of less than 20% of the purchase price of the home. The insurance can be paid monthly, at closing, or as a lump sum. There are several types of mortgage insurance, including private mortgage insurance (PMI), qualified mortgage insurance premium (MIP) insurance, and mortgage title insurance. It is important to note that mortgage insurance does not protect the borrower but helps them qualify for a loan by lowering the risk to the lender.
| Characteristics | Values |
|---|---|
| Who does mortgage insurance protect? | Mortgage insurance protects the lender or titleholder in case the borrower defaults on payments, passes away, or is otherwise unable to meet the contractual obligations of the mortgage. |
| Who needs mortgage insurance? | Mortgage insurance is generally required for homebuyers whose down payment is less than 20% of their new home's purchase price. However, there may be exceptions. It is also typically required for Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans. |
| Types of mortgage insurance | Private mortgage insurance (PMI), qualified mortgage insurance premium (MIP) insurance, mortgage title insurance, and lender-paid mortgage insurance (LPMI) are some common types. |
| Cost of mortgage insurance | The cost of mortgage insurance depends on the type of insurance and the loan. On average, it can be 0.1%–1% of the home loan amount annually. |
| Cancelling mortgage insurance | Mortgage insurance can often be cancelled once the borrower has paid off more than 20% of the full loan amount. |
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What You'll Learn
Private mortgage insurance (PMI)
PMI is not a permanent fixture of your mortgage payments. Lenders are required to cancel it when your mortgage balance drops to 78% of your home’s original value, or once you are halfway through your loan term, whichever comes first. You can also request that your lender remove the PMI once your mortgage balance is less than 80% of the original appraised value.
There are ways to avoid paying for PMI. One way is to make a 20% down payment on a home, which will help you avoid the PMI expense altogether. Another way is to take out a government-backed loan such as an FHA or USDA loan, which do not require PMI. Alternatively, you can take out a piggyback loan, where you make a 10% down payment and have two mortgages that cover the other 90%.
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Who does mortgage insurance protect?
Mortgage insurance, no matter the kind, protects the lender—not the borrower—in the event that the borrower falls behind on their payments. If the borrower defaults on their payments, passes away, or is otherwise unable to meet the contractual obligations of the mortgage, mortgage insurance makes up the difference so that the company that holds the mortgage is repaid the full amount.
Mortgage insurance can refer to private mortgage insurance (PMI), qualified mortgage insurance premium (MIP) insurance, or mortgage title insurance. Private mortgage insurance is paid monthly, with little or no initial payment required at closing. It is usually required if the down payment is less than 20% of the home's purchase price. The cost of PMI coverage can range from 0.5% to 6% of the amount of the loan, depending on the down payment, the type and term of the loan, and the borrower's credit score.
MIP insurance is required for all Federal Housing Administration (FHA) loans and costs the same regardless of the borrower's credit score, with only a slight increase in price for down payments of less than 5%. With FHA loans, the upfront cost of MIP insurance can be rolled into the mortgage, but this increases the overall cost of the loan.
Mortgage title insurance, on the other hand, is designed to protect the lender or heirs if the borrower dies while owing mortgage payments. It may pay off either the lender or the heirs, depending on the terms of the policy.
While mortgage insurance protects the lender, it can also benefit the borrower by decreasing the lender's financial risk and allowing borrowers with lower credit scores and smaller down payments to qualify for a home loan.
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When is mortgage insurance required?
Mortgage insurance is typically required when a borrower makes a down payment of less than 20% of the purchase price of the home. In this case, the lender will usually require the borrower to pay for private mortgage insurance (PMI) to lower their lending risk. The monthly PMI premium is included in the borrower's mortgage payment.
Federal Housing Administration (FHA) loans also typically require mortgage insurance, which is paid to the FHA. FHA mortgage insurance includes an upfront cost, paid as part of the closing costs, and a monthly cost included in the monthly payment. The upfront cost can be rolled into the mortgage, but this increases the loan amount and overall costs.
US Department of Agriculture (USDA) loans are similar to FHA loans, with insurance paid at closing and as part of the monthly payment. The upfront fee can also be rolled into the mortgage, but this will increase the loan amount and overall costs.
With Department of Veterans' Affairs (VA)-backed loans, the VA guarantee replaces mortgage insurance. There is no monthly mortgage insurance premium, but there is an upfront "funding fee" that varies based on different factors. This fee can also be rolled into the mortgage, but it will increase the loan amount and overall costs.
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How much does mortgage insurance cost?
Mortgage insurance is an insurance policy that protects a lender or titleholder if the borrower defaults on payments, dies, or is otherwise unable to meet the contractual obligations of the mortgage. It is important to note that mortgage insurance protects the lender, not the borrower, in the event that the borrower falls behind on their payments.
The cost of mortgage insurance varies depending on the type of insurance and loan, as well as the borrower's financial situation. Here is a breakdown of the costs associated with different types of mortgage insurance:
Private Mortgage Insurance (PMI)
Private mortgage insurance is typically required for conventional loans when the borrower makes a down payment of less than 20%. The cost of PMI depends on the down payment amount and the borrower's credit score. According to the Urban Institute's Housing Finance Policy Center, the average cost of PMI ranges from 0.46% to 1.5% of the original loan amount per year. For example, PMI on a $300,000 mortgage could cost between $1,380 and $4,500 per year, or between $115 and $375 per month. Borrowers with lower credit scores and smaller down payments will generally pay higher PMI rates.
Federal Housing Administration (FHA) Mortgage Insurance
FHA mortgage insurance is required for all FHA loans. Unlike PMI, the cost of FHA mortgage insurance is the same for all borrowers, regardless of their credit score. There is a slight increase in price for down payments of less than 5%. FHA mortgage insurance includes an upfront cost paid at closing and a monthly cost included in the borrower's monthly payment. Borrowers have the option to roll the upfront cost into their mortgage instead of paying it out of pocket, but this increases the overall loan amount and cost.
U.S. Department of Agriculture (USDA) Loans
USDA loans are similar to FHA loans but typically have lower upfront costs. The upfront guarantee fee is 1% of the loan amount, paid when the mortgage closes. There is also an annual fee of 0.35% of the average outstanding loan balance for the year, divided into monthly installments and included in the mortgage payment. Borrowers can choose to include this fee in their mortgage to avoid paying it out of pocket, but it will increase the overall loan amount and cost.
Department of Veterans Affairs (VA) Loans
VA-backed loans do not require monthly mortgage insurance premiums. However, borrowers must pay an upfront "funding fee", the amount of which varies based on several factors. This fee can also be rolled into the mortgage, but it will increase the overall loan amount and cost.
It is important for borrowers to understand the costs associated with mortgage insurance to make informed decisions about their loans and choose the option that best suits their financial situation.
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How to avoid paying mortgage insurance
Mortgage insurance is an insurance policy that protects the lender or title holder in case the borrower defaults on payments, passes away, or is otherwise unable to meet the contractual obligations of the mortgage. It is usually required when the borrower makes a down payment of less than 20% of the purchase price of the home. However, there are several ways to avoid paying for mortgage insurance.
Firstly, you can make a 20% down payment on a conventional home loan. This will help you avoid paying private mortgage insurance (PMI) as lenders typically require PMI when the down payment is less than 20%.
Secondly, you can consider a piggyback mortgage or an 80-10-10 loan, where you take out a second mortgage loan to cover 10% of the home's purchase price, effectively giving you a 20% down payment and helping you avoid mortgage insurance.
Thirdly, you can explore lender-paid mortgage insurance (LPMI), where the lender covers your mortgage insurance, but you pay a higher interest rate in return. While you are still paying for PMI in the form of interest, it eliminates the need for monthly premium payments.
Additionally, you can look into special first-time homebuyer loans without PMI or consider a Department of Veterans Affairs (VA) loan, which does not require a down payment or mortgage insurance, although there is a one-time funding fee. Similarly, USDA loans, backed by the U.S. Department of Agriculture, are zero-down-payment mortgages for lower- and moderate-income buyers in designated rural and suburban areas, although they come with upfront and annual fees.
Lastly, if you already have mortgage insurance, you can take steps to eliminate it sooner. For example, if your loan-to-original-value (LTOV) ratio falls below 80%, you may submit a written request to your mortgage servicer to cancel your PMI. You can also consider refinancing to a conventional loan to eliminate your mortgage insurance premium (MIP).
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Frequently asked questions
Mortgage insurance is an insurance policy that protects a lender or title holder in case a borrower defaults on their loan or mortgage payments. It also covers them if the borrower dies or is otherwise unable to meet the contractual obligations of the mortgage.
Mortgage insurance benefits the lender, not the borrower. It lowers the risk to the lender of making a loan to a buyer, so they can qualify for a loan that they might not otherwise be able to get.
Mortgage insurance is 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.
