What Is Mortgage Insurance? A Comprehensive Review

Mortgage insurance offers homebuyers the advantage of securing a competitive interest rate and qualifying for a loan with a minimal down payment of just 3%.

In return for these favorable conditions, borrowers commit to paying monthly insurance premiums for an extended period, typically spanning several years.

What Is Mortgage Insurance?

Mortgage insurance serves as a shield for mortgage lenders against potential default by borrowers.

By mitigating the lender’s risk, it facilitates loans to individuals who might otherwise be unable to secure a mortgage, let alone one within their financial means.

Traditionally, lenders mandate a 20% down payment to qualify for a mortgage. This requirement stems from the belief that borrowers who invest a significant sum of their own funds are more inclined to honor their payment obligations and avoid foreclosure, especially in the face of declining property values or personal financial setbacks.

The fallout of the 2007 housing crisis underscored the critical role of mortgage insurance in such circumstances.

Conventional loan applicants with lower down payments typically incur private mortgage insurance (PMI) costs, whereas those opting for loans backed by the Federal Housing Administration (FHA) incur a mortgage insurance premium (MIP).

What is property mortgage insurance
Image source (Forbes)

Types of Mortgage Insurance

There are four kinds of PMI:

  • Borrower-paid monthly. This is just what it sounds like—the borrower pays the insurance monthly typically as part of their mortgage payment. This is the most common type.
  • Borrower-paid single premium. You’ll make one PMI payment up front or roll it into the mortgage.
  • Split premium. The borrower pays part up front and part monthly.
  • Lender paid. The borrower pays indirectly through a higher interest rate or higher mortgage origination fee.

You might choose one type of PMI over another if it would help you qualify for a larger mortgage or enjoy a lower monthly payment.

There’s only one type of MIP, and the borrower always pays the premiums. But FHA loans don’t just have monthly MIPs.

They also have an up-front mortgage insurance premium of 1.75% of the base loan amount. In this way, the insurance on an FHA loan resembles split-premium PMI on a conventional loan.

How Does Mortgage Insurance Work?

Mortgage insurance appears in your monthly mortgage statement. It’s with your principal, interest, homeowners insurance, and property taxes.

Your servicer sends your premiums to the insurer.

What Does Mortgage Insurance Cover?

Mortgage insurance covers the lender. If you default on your home loan, the mortgage insurance company will reimburse your lender a percentage of the amount you owe.

Mortgage insurance essentially compensates for the down payment you didn’t make if the lender has to foreclose. It does not pay anything to the homeowner.

How Much Is Mortgage Insurance?

Mortgage insurance is a percentage of your home loan. Lower credit score and smaller down payment mean higher risk and more expensive premiums. As your balance falls, insurance costs decrease.

For monthly PMI, MGIC charges 0.17% to 1.86% annually, $170 to $1,860 per $100,000 on a 30-year fixed loan. That’s $35 to $372 monthly on a $250,000 loan.

On adjustable loans, PMI can hit 2.33%, $2,330 per $100,000 or $485 monthly on a $250,000 loan. PMI rises for second homes.

With FHA loans, under 5% down on a < $625,500 loan, MIP is 0.85% annually. MIPs range from 0.80% to 1.05%, $800 to $1,050 per $100,000 or $167 to $219 monthly on a $250,000 loan.

Higher down payments get lower rates, while loans > $625,500 have higher rates. Credit score doesn’t affect MIPs.

When Does Mortgage Insurance Go Away?

With PMI, you’ll pay monthly insurance premiums until you have at least 20% equity in your home. If you fall into foreclosure before that, the insurance company covers part of the lender’s loss.

With MIPs, you’ll pay for as long as you have the loan unless you put down more than 10%. In that case, you’ll pay premiums for 11 years.

How Is Mortgage Insurance Calculated?

Mortgage insurance correlates with the amount of your loan. To predict your mortgage insurance expenses, begin by computing your loan-to-value (LTV) ratio.

This involves dividing your loan amount by the appraised value of your property. Subsequently, multiply the result by your PMI percentage, obtainable from your lender.

If your lender’s PMI percentage is unavailable, you can utilize a range of PMI percentages from 0.22% to 2.25% for estimation purposes.

Pros and Cons of Mortgage Insurance

If you’re trying to decide whether mortgage insurance is worth the cost, consider these three essential pros and cons.

Pros

  • You can buy a home sooner. When you don’t have to save up for a 20% down payment—which could take a long time in a high-cost market—you can become a homeowner years earlier.
  • You can choose to make a smaller down payment. Even if you could put down 20%, you might prefer to keep that money in your emergency fund, use it for home renovations or put it toward retirement.
  • The expense could turn out to be a profitable investment. Your home may appreciate during the years you would have been saving up for a down payment—and it could end up being worth more than what you spend on mortgage insurance. It may even mean the difference between becoming a homeowner and getting priced out of a rapidly appreciating market.

Cons

  • Your monthly cost of homeownership will be higher. Even if it pays off in the long run (and it may not), you’ll feel the added expense in the short run. Plus, your monthly payment will be higher when your down payment is lower.
  • Your closing costs may be higher. With borrower-paid single premium or lender-paid PMI on a conventional loan, or with upfront mortgage insurance on an FHA loan, your closing costs may be higher.
  • You’ll have to deal with getting rid of it. Getting your lender to cancel PMI once you have enough equity can be a hassle and may require you to pay for an appraisal. Getting rid of FHA mortgage insurance may require refinancing into a conventional loan.

PMI vs. MIP

While PMI applies to conventional mortgages with less-than-standard down payments, you’ll likely need to pay MIP if you get an FHA loan. Here’s how they work:

Private Mortgage Insurance

This is typically required for conventional mortgage borrowers who put 3% to 19.99% down. Borrowers who pay PMI are more likely to be first-time homebuyers and are usually purchasing, not refinancing. They also tend to have slightly higher debt-to-income (DTI) ratios and lower credit scores than conventional borrowers who don’t pay PMI, according to the Urban Institute.

Mortgage Insurance Premiums

Borrowers with FHA loans must pay MIP. It helps them qualify for a home loan. Urban Institute says FHA borrowers typically have lower credit scores and more debt compared to those with conventional loans and PMI.

Around 30% of borrowers with guaranteed loans pay MIP. 42% pay PMI. 30% opt for VA loans, which don’t require PMI or MIP.

USDA loan borrowers pay a 1% upfront guarantee fee and a 0.35% annual mortgage insurance fee.

How To Get Rid of Mortgage Insurance

The process for getting rid of mortgage insurance depends on which type you have.

For a conventional mortgage with borrower-paid monthly premiums, you can get rid of PMI after you accumulate 20% equity by paying down your mortgage. You can also get rid of PMI if:

  • Your home’s value goes up enough to give you 25% equity, and you’ve paid PMI for at least two years
  • Your home’s value goes up enough to give you 20% equity, and you’ve already paid premiums for five years
  • You put extra payments toward your loan principal to reach 20% equity faster than you would have through regular monthly payments

You’ll need to ask your lender in writing to waive PMI if one of these things happens. For cancellation based on an increase in home value, your lender may require an appraisal. You’ll also need to be current on your payments and have a good payment history for the lender to grant cancelation at this point.

The passive way to get rid of insurance is to make mortgage payments every month until you have 22% equity. Federal law requires your lender to cancel PMI automatically at this point as long as you’re current on payments.

Another way you might get rid of PMI is through refinancing to get a lower rate or shorter term. You won’t need PMI on the new loan if your home’s value has gone up enough or you do a cash-in refi, which means making a lump-sum payment at closing to lower your mortgage balance.

Read more: Can you write off car insurance for business

How To Avoid Mortgage Insurance

If you’re getting an FHA loan, you can’t avoid mortgage insurance. If you’re getting a conventional loan, you’ll typically need to put down 20% to avoid insurance. You also have the option to save up a larger down payment and buy later, or buy a less expensive home.

An alternative to paying PMI on a conventional loan is to take out two mortgages instead of one. The first will cover 80% of the purchase price. The second will cover 10% to 17% of the purchase price and will have a higher interest rate. You’ll make a down payment of 3% to 10% to cover the rest of the purchase price.

These loans are sometimes called 80/10/10 loans or piggyback loans. Don’t assume that it will be less expensive to go this route; you’ll need to compare actual mortgage quotes to find out.

You may find special programs through your state or city for first-time homebuyers that can help you avoid PMI. Through certain lenders, you may also find low down payment mortgages that don’t require PMI.

For example, you may be able to put down just 3% without paying PMI if you have a modest income or are a first-time homebuyer, thanks to down payment and closing cost assistance. In exchange, you may have to complete a homebuyer education program.

If you’re a qualifying military service member, surviving spouse or member of the National Guard or reserves, you may qualify for a VA loan, which doesn’t charge insurance despite allowing a down payment as low as 0%.

Bottom Line

Considering personal and financial factors, opting to purchase a home earlier might seem advantageous despite the added expense of PMI or MIPs.

Many individuals believe that the benefits of mortgage insurance outweigh the drawbacks, as evidenced by the large number of borrowers who choose to pay for it rather than continue renting until they qualify for a loan without such requirements.

However, it’s also reasonable for borrowers to aim to reduce or avoid the increased monthly costs associated with insurance.

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