We may earn money or products from the companies mentioned in this post.
When buying a house with a mortgage loan, it is important to understand the costs that you are responsible for. One of these expenses can be mortgage insurance. Let’s take a look at what mortgage insurance is and how it works so you can make an informed decision when buying a home.
What is mortgage insurance?
In most cases, buying a home involves taking out a mortgage and paying a down payment. With a traditional mortgage, which is a home loan that is not federally guaranteed or insured, you must pay Personal Mortgage Insurance (PMI) if you pay less than 20%.
With an FHA mortgage backed by the US Federal Housing Administration, you pay for mortgage insurance regardless of the amount of your down payment.
Mortgage insurance is not required for USDA mortgages backed by the US Department of Agriculture and VA mortgages backed by the US Department of Veterans Affairs. However, there are fees to protect lenders in the event borrowers default. So you can still be responsible for the additional cost of these home loans in exchange for the small down payment requirement.
Be sure to ask your mortgage lender about your available mortgage insurance options Buying a mortgage loan.
How does mortgage insurance work?
As a borrower, you pay the cost of mortgage insurance each month when you are actually paying for the lender’s coverage. If you fail mortgage payments, your lender receives payments from the mortgage insurance provider. You are still responsible for paying off the mortgage loan.
Personal Mortgage Insurance vs. Mortgage Insurance Premiums
Mortgage insurance comes in two forms: Private Mortgage Insurance (PMI) and mortgage insurance premiums (MIP).
Conventional home loan recipients with a down payment of less than 20% pay private home loan insurance. Depending on the borrower’s creditworthiness, the PMI rate goes up or down. PMI rates are often lower than MIP rates. Most often, PMI is part of your monthly payment and includes little or no initial payment at signup.
FHA borrowers pay mortgage insurance premiums instead of PMI. MIP rates do not vary with borrower creditworthiness, but are lower for borrowers who can make a down payment greater than 5%. A MIP payment is due upfront at closing and thereafter with each monthly mortgage payment. MIP also has an annual fee that the borrower must pay.
How much is the mortgage insurance?
With PMI, you can expect to pay anywhere from 0.05% – 1% of your home loan. With a MIP, you can expect to pay 1.75% of your home loan.
Your deposit is the number one factor influencing how much PMI you will pay. However, other considerations come into play, such as:
- The PMI type (more on this below)
- Type of mortgage rates: fixed or adjustable
- The term of the mortgage
- The loan-to-value (LTV) ratio
- The sum insured required by your lender
- The creditworthiness of the borrower
- The appraisal of the house
How to calculate mortgage insurance
As mentioned above, PMI rates vary between 0.05% and 1% of your home loan. For MIP on an FHA loan, the interest rate is typically 1.75%. Here’s how the payments for a $500,000 house break out with a 30-year loan at a 5% fixed rate.
mortgage insurance % | purchase price | down payment | basic loan amount | Annual PMI | MIP | Base payment 30 years. fixed 5% | Monthly payment with PMI or MIP |
---|---|---|---|---|---|---|---|
0.05 | $500,000 | 5% | $475,000 | $2,375 | – | $2,550 | $2,748 |
1.00 | $500,000 | 5% | $475,000 | $4,750 | – | $2,550 | $2,946 |
1.75 | $500,000 | 5% | $475,000 | – | $8,313 | $2,604 | $3,297 |
Types of Personal Mortgage Insurance (PMI):
Each type has its own advantages that are suitable for different situations. Choosing the right one can put you in an ideal position for home buying.
Borrower-Paid Mortgage Insurance (BPMI)
This is the most common type of PMI, paid monthly along with the loan payments. Typically, borrowers pay 0.5%-1% of their loan amount per year for PMI. For a $500,000 home, that’s $2,500 to $5,000 a year, or an additional $208 to $417 a month. With borrower-paid PMI, you pay BPMI each month until you have 20% equity in your home (based on the original purchase price).
Lender-Paid Mortgage Insurance (LPMI)
With lender-paid PMI, instead of paying a monthly PMI payment attached to the mortgage payment, the borrower pays a higher interest rate or mortgage origination fee to get the amount needed for insurance, thus paying the lender indirectly. The lower the borrower’s credit rating, the higher the interest rate. In this way, the lender is safer with the loan. The LPMI rate typically adds 0.25% to 0.5% to the interest rate. LPMI is a good option if you want a lower monthly payment or qualify for a larger loan. The downside of LPMI is that even if you reach 20% equity, your interest rate won’t go down unless you refinance.
Borrower-Paid Single Premium Mortgage Insurance (SPMI)
This type of payment is possible if you have additional savings and want to cover your PMI up front. In this case, the borrower makes a PMI prepayment or funds it into the loan at closing. Upfront payment results in a lower monthly payment. A lump sum payment is non-refundable. Unlike home or car insurance premiums, mortgage insurance premiums aren’t prorated and refunded if you decide to refinance or move after a few years.
Split premium mortgage insurance
Split-premium mortgage insurance is the least common type – it’s a combination of BPMI and SPMI. With this option, you pay part of the mortgage insurance as a lump sum when you sign up and part monthly. You don’t have to put up as much extra money up front as with SPMI, nor do you add as much to your monthly payment as with BPMI. One reason to opt for split-premium mortgage insurance is if you have a high debt-to-income ratio. If that’s the case, increasing your monthly payment with BPMI too much would mean you wouldn’t qualify to borrow enough to buy the home you want.
Unlike the interest on your home loan of $750,000 or less, PMI payments are not tax deductible.
Mortgage Insurance Premium (MIP)
This type of mortgage insurance is for FHA loans. There is only one type of MIP for FHA loans, and there is no lender-paid option. The borrower pays part of the premium upfront at closing and continues to make a monthly premium payment. Borrowers also pay an annual MIP payment. Annual MIP payments are approximately 0.45% – 1.05% of the base loan amount.
In most cases, the borrower will pay mortgage insurance for the term of the loan unless their down payment is 10% or more. In this case, the lender would scrap MIP after 11 years.
How long do you need to have mortgage insurance?
How long a borrower is required to have mortgage insurance depends on the type of loan and the amount of the down payment. A traditional loan with less than 20% default requires PMI until 20% of the loan is repaid. At this point, the borrower can request removal of the PMI.
PMI eventually ends in most cases.
Once the mortgage LTV ratio drops to 78% — meaning your down payment plus the loan amount you’re repaying equals 22% of the home’s purchase price — federal homeowner protection law requires the lender to automatically cancel the insurance.
In contrast, MIP remains an obligation for the life of the loan unless the borrower makes a down payment of more than 10%. In this case, the borrower would pay MIP for 11 years.
There are a few alternatives to paying PMI on a traditional loan
piggyback loan
A piggyback loan helps a traditional borrower avoid PMI. With a piggyback loan, the borrower takes out two loans. The first loan will cover 80% of the purchase price and the second loan will cover between 10% and 17% of the home sale but at a higher interest rate. With a piggyback loan, the borrower then needs a down payment of 3-10%.
Piggyback loans are also called 80/10/10 loans. Because the borrower applies for two separate loans and the total payment amount may be more expensive. Compare and break down actual offers to see if a piggyback loan is right for this situation. With this lending method, the borrower repays two separate loans.
Down payment assistance (DPA) programs or closing cost assistance
Your state or local government may have special rules Programs to support first-time home buyers Avoid PMI. Requirements typically include completing a homebuyer education program, which could help you qualify for down payment and closing cost assistance and avoid PMI. Check with your local government what programs are available before applying for a mortgage – your lender should be able to direct you to such resources. There are more than 2,000 DPA and closing costs statewide assistance programs and DPA programs vary by location.
A final word on mortgage insurance
The type of mortgage insurance, the length of time you have to pay, and your insurance plan all depend on it Type of mortgage loan You are applying and your individual financial situation. When purchasing a mortgage loan, ask your lender about the different mortgage insurance options available and the costs involved.