Mortgage Insurance: What Is It And When Is It Needed?
If you’re shopping for a mortgage, you may have come across the term “mortgage insurance.” But what is mortgage insurance, and why do you need it?
Mortgage insurance is required on most home loans with a down payment of less than 20 percent.
The purpose of mortgage insurance is to protect the lender—not the borrower—in the event that the borrower defaults on the loan.
If you’re considering a home loan with less than a 20 percent down payment, you will most likely be required to purchase mortgage insurance.
In this article, we’ll discuss the different types of mortgage insurance and their associated costs.
What Is Mortgage Insurance?
Mortgage insurance is a type of insurance that protects lenders from the financial loss that can occur when a borrower defaults on their home loan. Mortgage insurance can be either private or public, and it allows borrowers to qualify for loans that they might not otherwise be able to obtain.
Types of Mortgage Insurance
Borrower-Paid Mortgage Insurance
As the name suggests, with this type of mortgage insurance, the borrower is responsible for paying the monthly premiums. This type of mortgage insurance is typically required when the borrower has less than 20% equity in the home.
Borrower-Paid Single Premium Mortgage Insurance
With this type of mortgage insurance, the borrower pays a one-time premium at closing. The amount of the premium is determined by the size of the loan and the initial loan-to-value ratio.
Split Premium Mortgage Insurance
Split premium mortgage insurance is a combination of the two previous types of mortgage insurance. The borrower pays an up-front premium at closing as well as monthly premiums throughout the life of the loan.
Lender-Paid Mortgage Insurance
Lender-paid mortgage insurance (LPMI) is paid by the lender rather than the borrower. The benefit of LPMI is that it may allow borrowers to qualify for a lower interest rate; however, it does not protect the lender as much as other types of mortgage insurance.
How Much Is Mortgage Insurance?
The cost of mortgage insurance varies depending on a number of factors, including the type of loan you have, the amount of your down payment, and the length of your loan term.
However, you can typically expect to pay between 0.5% and 1% of your loan amount each year for mortgage insurance.
For example, if you borrow $250,000 for a 30-year mortgage with a 10% down payment, you will likely pay about $1,875 per year for mortgage insurance.
Private Mortgage Insurance vs. Mortgage Insurance Premiums
You will more than likely need to pay MIP if you get an FHA loan. PMI applies to conventional mortgages with smaller down payments, but here’s how they operate:
Private Mortgage Insurance (PMI)
A conventional mortgage typically requires a down payment of 20%, but many lenders now offer loans with a down payment of 3%.
The trade-off for this lower down payment is that the borrower will be required to pay for private mortgage insurance or PMI.
PMI borrowers are more likely to be first-time buyers and, in most cases, are not refinancing their homes. According to the Urban Institute, they also have higher debt-to-income (DTI) ratios and lower credit scores than regular borrowers who don’t pay PMI.
Homebuyers can use a PMI calculator to get an estimate for the monthly cost of PMI, which will depend on the size of their home loan, credit score, and other details.
Mortgage Insurance Premium (MIP)
This is a requirement for people who take out an FHA-backed loan. The primary reason to pay MIP is that, in some cases, it’s the only way you can qualify for a home loan. According to the Urban Institute, FHA borrowers have lower credit scores and more debt relative to their income than conventional borrowers who pay PMI.
The percentages vary from year to year, but on average, about 30% of borrowers with a loan guarantee or mortgage insurance pay MIP. Another 42% pay PMI, and the remaining 30% take advantage of the loan program offered by the Department of Veterans Affairs (VA), which includes a lender guarantee but doesn’t require PMI or MIP.
If you take out a loan that is backed by the USDA, then you will have to pay an annual mortgage insurance fee of 0.35% as well as an upfront guarantee fee that is 1% of the total loan amount monthly.
How To Avoid Mortgage Insurance
Mortgage insurance is designed to protect mortgage lenders in the event that a borrower defaults on their loan. For borrowers, mortgage insurance can be an additional expense that must be paid each month.
FHA loans require borrowers to pay mortgage insurance regardless of how much money they put down. For conventional loans, borrowers must typically put down 20% in order to avoid paying mortgage insurance.
Fortunately, there is an alternative to paying PMI on a conventional loan. If you are unable to make a 20% down payment, you can take out two mortgages instead of one.
The first mortgage will cover 80% of the purchase price, and the second mortgage will cover 10% to 17% of the purchase price.
The second mortgage will have a higher interest rate, but you will not have to pay for PMI.
You’ll still need to make a down payment of 3% to 10% of the purchase price, but this option can save you money in the long run.
There are also special programs available that can help first-time buyers avoid PMI. These programs, which are typically offered by state and local governments, provide low-interest loans or grants that can be used for a down payment.
As a result, these programs can help make homeownership more affordable for buyers who might otherwise struggle to come up with the necessary funds.
How to Get Rid of Mortgage Insurance
The method for eliminating mortgage insurance is determined by which type you have.
If you have a conventional loan, it can be stopped when:
- 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
To have your PMI waived, you’ll need to contact your lender once one of these things happens. They will likely require an appraisal, and you’ll also need to be in good standing.
In accordance with federal law, your lender is required to drop PMI from conventional loans once they’ve reached 22% equity, as long as the borrower is current on payments.
Another way to get rid of mortgage insurance is to refinance into a new loan.
This option is available with both conventional and government-backed loans. With a conventional loan, you can refinance once you reach 20% equity in your home.
With an FHA loan, you can refinance into a new loan at any time. However, keep in mind that this will reset the clock on your loan term, and you’ll have to pay closing costs again.
Paying a mortgage insurance premium can be a lifesaver for homeowners, but it’s important to understand what it is and when you need it.
If you are in the market for a new home or are considering refinancing your current mortgage, be sure to get in touch with Radius. Our team of experts will help you find the best mortgage options available, including those that don’t require private mortgage insurance.