What is Mortgage Insurance?
Mortgage insurance is a type of insurance policy that protects the insurance lender in case the borrower defaults on payment, passes away, or is unable to fulfill the terms of the mortgage. Your mortgage insurance is a fee you pay to lower the risk to a lender offering a loan so that you can qualify for a mortgage you otherwise wouldn’t get.
Unlike other types of homeowners insurance, mortgage insurance protects the lender and not the borrower. When taking a conventional mortgage, you need to put down at least 20% of the cost of the property. If you pay less than 20% upfront, you will pay mortgage insurance, as the lender will bear more risk in giving you a mortgage. Once you’ve paid off a portion of your loan, you may be able to cancel your payments.
This may require regular premium payments or a lump-sum payment at the time of origination.
Types of Mortgage Insurance
Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) is a type of insurance that lenders require when a borrower makes a down payment of less than 20% of the purchase price of a home. Its purpose is to protect the lender from losses if the borrower defaults on loan repayments. While it benefits the lender and not the borrower, PMI allows borrowers to qualify for a mortgage with a lower down payment. PMI payments can be canceled once the owner has built enough equity in the home (typically 20% of the original purchase price).
Qualified Mortgage Insurance Premium (MIP)
Qualified mortgage insurance premium (MIP) provides a similar type of insurance as PMI, but it applies to the US Federal Housing Administration (FHA) backed mortgage payments. FHA-backed lenders use MIPs to guard against higher-risk borrowers who have a higher chance of loan default. Every borrower who takes an FHA mortgage is required to have mortgage insurance. MIP is paid upfront at closing and annually, depending on the size of your down payment.
Mortgage Title Insurance
Mortgage title insurance protects lenders and borrowers from financial losses due to title defects or property ownership issues. Some common title issues that this type of insurance can safeguard against include forgery, fraud, errors in public records, and easement or boundary disputes.
Mortgage Protection Life Insurance
Mortgage protection life insurance is designed to pay off the balance of a mortgage if the borrower passes away. It is intended to protect the borrower’s family from being burdened with mortgage payments in the event of their death.
Who Needs Mortgage Insurance?
Typically, homebuyers with a down payment of less than 20% of the property value must take out mortgage insurance. Some other scenarios include:
FHA Loans
Federal Housing Administration (FHA) loans require it regardless of the down payment amount.
Veteran Affairs (VA) Loans
While VA loans may not necessarily require mortgage insurance, you may need to pay a funding fee at closing.
USDA Loans
The United States Department of Agriculture (USDA) may require mortgage insurance if your initial payment is less than 20% of the loan amount.
Refinancing
You may need mortgage insurance if you refinance your mortgage with a new loan that covers over 80% of the home’s value.
Benefits
Mortgage insurance offers a range of benefits to both borrowers and lenders:
Ease of Homeownership
This helps borrowers who may not have enough savings for a large down payment to become homeowners sooner. Borrowers with lower credit scores or higher debt-to-income ratios may find owning a home with mortgage insurance easier. Some renters may also discover that they can own a home with similar monthly payments as their rent.
If you’re considering owning a second home or a vacation property, there are options that can make it easier to finance your purchase.
Increased Flexibility
They are flexible and can be used to offset other costs associated with buying a home, such as appraisal fees or closing costs.
Better Interest Rates
Mortgage insurers may offer better interest rates to borrowers, saving them money on their mortgage repayments.
How Much Will You Pay?
The cost of mortgage insurance depends on several factors, including:
Your Credit Score
A higher credit score can lead to lower premiums, while a lower credit score can result in higher premiums.
Down payment
The lower your down payment, the higher the premiums you may have to pay.
Property Type
Premiums may be affected by the type of property being insured. Investment property or second homes may require higher premiums than single-family homes or condos.
Loan Term
You may need to pay higher premiums on loans with longer repayment terms.
Generally, the cost of private insurance ranges from 0.46% to 1.5% of the original loan amount annually, so if you took a $300,000 mortgage, you would have to pay between $115 and $375 per month.
FHA loans require an annual premium of between 0.45% and 1.05%, so on a $300,000 loan, you will pay between $112.50 and $262.50 per month. They also require an upfront payment of 1.75% of the total loan amount. This figure comes down to $5,250 for a $300,000 loan.
VA loans have a funding fee ranging from 1.25% to 3.3% of the initial loan amount. This means that for a $300,000 loan, you will have to pay between $312.50 and $825 per month.
USDA loans require an upfront payment of up to 3.5% of the loan amount as well as an annual fee of 0.5% of the loan amount. This means that for a $300,000 loan, you will pay $10,500 upfront and a monthly fee of $125.
In Summary
Mortgage insurance is a vital component of home-buying as it helps borrowers purchase a home with a small down payment. It also helps lenders mitigate the risk of default, allowing buyers to own homes that may otherwise be out of reach.
