What Is Mortgage Insurance?

If you don’t have enough savings for a 20% down payment, mortgage insurance could help. This type of insurance helps buyers put down smaller down payments on a home by providing added reassurance for the lender. 

Learn more about how it works, what it can cost, and what you need to know if you want to avoid it.
 

What is mortgage insurance?

Mortgage insurance is an added expense you’ll need to consider when you take out a mortgage with less than 20% down. The insurance protects your lender against the risk that you might default on your loan. 

Depending on the type of mortgage you get, you might pay mortgage insurance for as long as you own the house. You may be able to get rid of it once you reach 20% equity in the home.

Paying extra might seem annoying, but look at it this way: By paying mortgage insurance, you can buy a home you might not otherwise be able to afford with a traditional down payment.

“We love mortgage insurance,” said Kelly Cort, a California-based senior loan officer at Guild Mortgage. “It helps people get into properties before they have the ability to save 20%.” 

By paying PMI, homebuyers can immediately begin building equity instead of saving and waiting while continuing to rent. In most cases, the opportunity for appreciation is much higher than the cost of PMI, she said.

How does mortgage insurance work?

Mortgage insurance is often calculated as a percentage of the overall loan amount, such as 1.5%. Your loan disclosure agreement will determine how much you can expect to pay.

Usually, you’ll either pay a mortgage insurance premium monthly, upfront at closing, or both. It depends on what kind of mortgage insurance you have, and that depends on the type of mortgage. 

“You can minimize mortgage insurance by having a better credit score and also by having a larger down payment,” said Michael Espinosa, a Certified Financial Planner based in Salt Lake City. If your credit score isn’t great, then the type of mortgage you choose could determine whether the mortgage insurance is more affordable for you.

What are the different types of mortgage insurance?

There are several different types of mortgage insurance. They vary based on the type of loan, whether it’s government-backed, and who pays the premium. 

Private mortgage insurance

Private mortgage insurance (PMI) is for conventional loans, which are your basic everyday mortgages. If your down payment is less than 20%, your lender will require you to pay PMI. 

You’ll usually pay PMI as a monthly premium alongside your mortgage principal and interest payment. The amount will depend on how much you put down and your credit score. Usually, it adds up to about 1% or 2% of the loan amount (but sometimes can be as much as 6%).

In some cases, you can request to drop PMI when you’ve reached 20% in equity. That can lower your mortgage payment, saving you money each month. According to Reed Letson, owner of Elevation Mortgage, once you hit 22% equity (based on the original purchase price), PMI can be dropped automatically.

FHA mortgage insurance

If you choose a loan backed by the Federal Housing Administration (FHA), you’ll be required to pay mortgage insurance premiums (MIP). 

Mortgage insurance for FHA loans typically includes an upfront premium of 1.75% and an ongoing monthly premium. Although, you may be able to roll the upfront cost into the loan.

The cost of the annual premium varies depending on the loan amount, term length, and down payment, but is generally 0.55% for 30-year loans with 3.5% down.

You’ll need to keep paying your MIP for as long as you have the loan, unless you put down more than 10%. In that case, you’ll keep paying mortgage insurance for the first 11 years of the loan. Otherwise, you'll need to refinance if you want to get rid of mortgage insurance.

Insurance for USDA loans

Loans backed by the U.S. Department of Agriculture (USDA) also require insurance payments, although they aren’t called mortgage insurance. 

USDA borrowers pay a 1% upfront fee and an annual guarantee fee of 0.35% of the loan amount (divided into monthly installments).

Insurance for VA loans

Veterans and service members who choose a VA loan don’t pay mortgage insurance. Instead, the Department of Veterans Affairs (VA) requires an upfront funding fee. 

This fee can be up to 3.3% of the loan amount. Though some disabled veterans may be exempt from paying it.

Borrower-paid mortgage insurance

When you pay the mortgage insurance as the borrower, it’s considered borrower-paid mortgage insurance (BPMI). Borrower-paid is the most common arrangement for mortgage insurance.

Lender-paid mortgage insurance

If the lender arranges to pay the mortgage insurance, it’s called lender-paid mortgage insurance. As nice as that may sound, you should still run the numbers, as the tradeoff may be a higher mortgage rate. 

“Think of this as a lender credit, but instead of going towards closing costs, it goes toward the PMI buyout,” Letson said.

How can you avoid or cancel mortgage insurance?

There are several ways to get rid of mortgage insurance. Here are the most common: 

• Put 20% down: With at least 20% on a conventional mortgage, you won’t have to pay mortgage insurance.
• Choose a single premium PMI: This allows you to make a single payment to remove the PMI from a conventional mortgage, according to Letson. 
• Go for lender-paid PMI: You won’t need to pay out of pocket, as the lender will cover the PMI for you, but you’ll usually pay a higher interest rate.
• Request it: Once your mortgage balance is 80% of the value of your home, you can request that the mortgage servicer remove the PMI.
• Wait for it to happen automatically: PMI will be automatically dropped when you reach 22% equity in your home (based on the original purchase price).
• Refinance: Once you have 20% equity in your home (based on current value), refinance into a loan without mortgage insurance.