Mortgage insurance lowers the risk to the lender of making a loan to you, so you can qualify for a loan that you might not otherwise be able to get.
Typically, borrowers making a down payment of less than 20 percent of the purchase price of the home will need to pay for mortgage insurance. Mortgage insurance also is typically required on FHA and USDA loans. Mortgage insurance lowers the risk to the lender of making a loan to you, so you can qualify for a loan that you might not otherwise be able to get. But, it increases the cost of your loan. If you are required to pay mortgage insurance, it will be included in your total monthly payment that you make to your lender, your costs at closing, or both.
Mortgage insurance, no matter what kind, protects the lender – not you – in the event that you fall behind on your payments. If you fall behind, your credit score may suffer and you can lose your home through foreclosure.
There are several different kinds of loans available to borrowers with low down payments. Depending on what kind of loan you get, you’ll pay for mortgage insurance in different ways.
If you get a Conventional Loan, your mortgage broker may arrange for mortgage insurance with a private company. Private mortgage insurance (PMI) rates vary by down payment amount and credit score but are generally cheaper than FHA mortgage insurance premiums for borrowers with good credit. Most private mortgage insurance is paid monthly, with little or no initial payment required at closing. Under certain circumstances, you may be able to cancel your PMI.
If you get a FHA mortgage loan, your mortgage insurance premiums are paid to the Federal Housing Administration (FHA). FHA mortgage insurance is required for all FHA loans. It costs the same no matter your credit score, with only a slight increase in price for down payments less than five percent. FHA mortgage insurance includes both an upfront cost, paid as part of your closing costs, and a monthly cost, included in your monthly payment.
If you don’t have enough cash on hand to pay the upfront fee, you are allowed to roll the fee into your mortgage instead of paying it out of pocket. If you do this, your loan amount and the overall cost of your loan will increase.
If you get a US Department of Agriculture (USDA) loan, the mortgage insurance is similar to the FHA loan, but typically cheaper. You’ll pay for the insurance both at closing and as part of your monthly payment. Like with FHA loans, you can roll the upfront portion of the insurance premium into your mortgage instead of paying it out of pocket, but doing so increases both your loan amount and your overall costs.
If you get a Department of Veterans’ Affairs (VA) loan, the VA guarantee replaces mortgage insurance, and functions similarly. With VA-backed loans, which are loans intended to help servicemembers, veterans, and their families, there is no monthly mortgage insurance premium. However, you will pay an upfront funding fee. The amount of that fee varies based on:
Like with FHA and USDA loans, you can roll the upfront fee into your mortgage instead of paying it out of pocket, but doing so increases both your loan amount and your overall costs.
As an alternative to mortgage insurance, some brokers may offer what is known as a “piggyback” second mortgage.
This option may be marketed as being cheaper for the borrower, but that doesn’t necessarily mean it is. Always compare the total cost before making a final decision. Learn more about piggyback second mortgages.
Years ago, a 20% down payment was a requirement for obtaining a Utah mortgage loan. Putting that much money down made it less likely that borrowers would simply default on their home loans and gave lenders a measure of security and collateral in the case of foreclosure.
However, in more recent years, lenders have gotten much more creative in financing to help more Americans become homeowners. There are now mortgage loans that require as little as 3% down up front. In order to compensate for that added risk of loss, lenders require borrowers with a down payment of less than 20% to pay for mortagage insurance. This protects the lender from monetary losses.
Mortgage insurance is paid to either a private mortgage insurance or government agencies guarantees the mortgage company will recoup their losses if the borrower defaults. The borrower will pay a premium each month and/or an upfront premium that is typically added to their loan amount.
If you are in the market for a home loan but are not sure you can scrape together a large enough down payment to avoid mortgage insurance, here are four reasons you should think about saving a little longer:
Fewer Tax Breaks – PMI used to be completely tax deductible, but as of 2018 that tax haven has been completely cut out of the law. You will have to factor in how that will affect your personal tax situation.
Higher Mortgage Payment – PMI usually gets rolled into your total monthly mortgage payment. PMI premiums range between 0.5% and 1% of the home loan amount annually. That can add up to a couple extra hundred dollars a month that you’ll have to pay for an indeterminate amount of time.
Early Cancellation – Thanks to the Homeowner’s Protection Act (HPA) of 1998, homeowners have the right to request private mortgage insurance cancellation when they reach a 20% equity in their home. What’s more, lenders are required to automatically cancel PMI coverage when a 78% loan-to-value is reached. Some exceptions do apply, such as liens on the property or not keeping up with payments, may require further PMI coverage.
Lost Investment Opportunities – If it ends up taking years for you to earn 20% equity in your property that will mean years of having given up money to an insurance company when you could have been investing that cash for your own benefit.
Of course, there may be some situations when paying PMI makes sense. Most often this is when you are buying in an area with strong home price appreciation or if your down payment is very close to 20% and you know you will be able to put down the rest soon. And first-time homebuyers often find PMI worth the cost in order to break into the housing market.
However, in most other situations, simply saving up a full 20% down payment is the safest way to take on a mortgage home loan. It also ensures that you let your money work for you and not the other way around.
PMI is required on conventional loans if the loan-to-value ratio is greater than 80%. PMI fees vary, depending on the size of the down payment and your credit score. Under certain circumstances, PMI cancellation is possible at 80% loan-to-value. It is also possible to pay for your mortgage insurance taking a higher interest rate instead of paying a monthly insurance premium. This often will result in a lower monthly payment.
MIP is required on all FHA loans. FHA loans with greater than 90% LTV, mortgage insurance is required for the life of the loan. When the LTV on an FHA loan has 90% or less, MIP is required for the first 11 years.
BPMI is the most common type of PMI. When you read about PMI and the type isn’t specified, this is usually the kind that’s being discussed. BPMI comes in the form of an additional monthly fee that you pay with your mortgage payment. After your loan closes, you pay BPMI every month until you have 22% equity in your home based on the original purchase price. At that point the lender must automatically cancel BPMI, as long as you’re current on your mortgage payments. Accumulating enough home equity through regular monthly mortgage payments to get BPMI canceled generally takes about 11 years.
LPMI is when your mortgage lender will technically pay the mortgage insurance premium. In fact, you will actually pay for it over the life of the loan in the form of a slightly higher interest rate. Unlike BPMI, you can’t cancel LPMI when your equity reaches 78% because it’s built into the loan. Refinancing will be the only way to lower your monthly payment. Your interest rate will not decrease once you have 20% or 22% equity.
The benefit of lender-paid PMI, despite the higher interest rate, is that your monthly payment is often lower compared with making monthly PMI payments, and you could qualify to borrow more.