If you’re putting down less than 20% on your home, you’ll likely encounter mortgage insurance. But what is it, and why is it necessary? In this guide, we’ll break down the purpose of mortgage insurance, how it protects lenders, and what it means for you as a borrower.

What Is Mortgage Insurance?

Mortgage insurance is a type of financial protection for lenders. When a lender issues a loan, they take on considerable risk. Loans with lower down-payments are considered riskier loans and because of that, the lender issues mortgage insurance to offset their exposure. Its additional money paid on a monthly basis that ensures that the lender is compensated if a borrower defaults on the loan. While it doesn’t directly benefit the borrower, it can open doors to homeownership by allowing buyers to secure a mortgage with a lower down payment.

Types of Mortgage Insurance

1. Private Mortgage Insurance (PMI)

• Applies to conventional loans when your down payment is less than 20%.
• Typically required until your loan-to-value (LTV) ratio reaches 78% or 80% through payments or home appreciation.
• PMI costs vary depending on your credit score, loan size, and down payment amount.

2. Mortgage Insurance Premium (MIP)

• Required for loans backed by the Federal Housing Administration (FHA).
• Includes both an upfront premium (usually 1.75% of the loan amount) and annual premiums broken down and paid monthly.
• Remains for the life of the loan unless you refinance into a conventional loan.

3. USDA and VA Loans

• USDA Loans: Include a guarantee fee, which acts similarly to mortgage insurance.
• VA Loans: Do not require mortgage insurance but may have a funding fee.

How Is Mortgage Insurance Calculated?

The cost of mortgage insurance is usually expressed as a percentage of your loan amount. Here’s how it typically breaks down:

• PMI: 0.3% to 1.5% of the original loan amount annually.
• MIP: 0.45% to 1.05% of the loan amount annually, depending on the loan size, term, and down payment.
• USDA Guarantee Fee: 1% upfront fee plus an annual fee of 0.35%.

For example, if you borrow $300,000 with a PMI rate of 0.5%, you’d pay approximately $1,500 annually or $125 per month.

Why Do Lenders Require Mortgage Insurance?

Lenders take on greater risk when a borrower has less equity in the home. Mortgage insurance provides a safety net for lenders by covering a portion of their potential loss in case of default.

How Does Mortgage Insurance Impact Borrowers?

Advantages

• Lower Down Payment: Enables you to buy a home sooner without saving for a 20% down payment.
• Improved Loan Accessibility: Helps more buyers qualify for loans.
• Equity Growth: You can build equity faster by purchasing a home earlier.

Disadvantages

• Added Cost: Monthly premiums increase your overall housing expense.
• No Direct Benefit: Mortgage insurance primarily protects the lender, not you.

How to Remove Mortgage Insurance

Conventional Loans (PMI)

• Automatic Removal: Lenders must cancel PMI once your LTV ratio reaches 78% based on the original loan value.
• Request Removal: You can request cancellation when your LTV reaches 80%, but you may need to prove the home’s value with an appraisal. Based on the amount of time that’s passed, different loan-to-value requirements may exist.

FHA Loans (MIP)

• Refinance: The only way to remove MIP is to refinance into a conventional loan after you’ve built at least 20% equity in your home.
  • You don’t need to have 20% equity to refinance into a conventional loan. If there is a great rate and monthly payment benefit, you may still be able to refinance into a conventional loan even if you don’t have that 20%! For example, say you refinance and you have an 82% loan-to-value- when you’ve paid your loan down to 78%, the mortgage insurance will remove!

Can You Avoid Mortgage Insurance?

If you prefer not to pay mortgage insurance, consider these options:

1. 20% Down Payment: Avoids PMI on conventional loans.
2. Piggyback Loans: Use a second loan to cover part of your down payment and avoid PMI. However, these separate loans still have monthly payments and often times come at higher interest rates.

Tips for Managing Mortgage Insurance

• Before Buying- Credit Matters: Your credit score plays a part in your mortgage insurance when you close. If you know you’ll be buying with less than 20% down, work to ensure your credit score is in the best position it can be.
• After You Close- Monitor Your Equity: Track your progress toward 20% equity to remove PMI sooner! This is part of our job, too! When you work with us, you’re not working with a transactional Loan Officer. We’re with you long-term. When we check in, usually a few times a year, we’ll ask about your homes value to see if there may be an opportunity to remove your mortgage insurance!
• Understand Your Loan Terms: Be clear on how and when mortgage insurance can be canceled. We’ll help provide resources so you know your options.

Final Thoughts

While mortgage insurance adds to the cost of homeownership, it’s often a worthwhile trade-off for buying a home sooner with less upfront cash. By understanding how it works and exploring your options, you can make informed decisions about your mortgage.

If you have questions about mortgage insurance or need help finding the best loan for your needs, we’re here to help!