What is mortgage insurance? How it works, when it’s needed

The traditional goal of a down payment on a home is 20% of the purchase price, but that’s out of reach for many buyers.

Mortgage loan insurance allows you to sell a smaller property advance payment and still eligible for a home loan. It protects the lender in the event of default on the loan.

With a conventional mortgage – a home loan that is neither guaranteed nor insured by the federal government – a lender will ask you to pay for private mortgage insurance, or PMI, if you put less than 20% down.

With an FHA mortgage, backed by the United States Federal Housing Administration, you will pay for mortgage loan insurance regardless of the down payment amount.

USDA mortgages, guaranteed by the US Department of Agriculture, and VA mortgages, guaranteed by the US Department of Veterans Affairs, do not require mortgage insurance. But they have a fee to protect lenders in the event of borrower default. So, you will always have to face an additional cost with these home loans in exchange for the low down payment requirement.

How does mortgage loan insurance work?

You bear the cost of mortgage insurance, but it covers the lender. Mortgage insurance pays the lender a portion of the principal if you stop making mortgage payments. During this time, you are still obligated to pay off the loan if you can’t pay it, and you could lose the home to foreclosure if you fall too late.

This is different from mortgage life insurance, which pays off the mortgage balance if the borrower dies, or Mortgage Disability Insurance, which eliminates the mortgage if the borrower becomes disabled.

PMI vs MIP and other fees

Home loan insurance works a little differently depending on the type of mortgage loan. Here’s what you need to know about conventional and government guaranteed mortgages.

PMI for conventional mortgages

Many lenders offer conventional mortgages with low down payment requirements, some as high as 3%. A lender will likely require you to pay private mortgage insurance, or PMI, if your down payment is less than 20%.

Before you buy a home, you can use a PMI calculator to estimate the cost of the PMI, which will vary based on your mortgage amount, credit rating, and other factors. Typically, the monthly PMI premium is included in your mortgage payment. You can ask cancel PMI once you have more than 20% equity in your home.

FHA Mortgage Insurance Premium (MIP)

FHA loans have minimum down payments as low as 3.5% and have easier credit qualifications than with conventional loans. Most FHA home loans require an initial mortgage insurance premium and an annual premium, regardless of the amount of the down payment. The initial premium is 1.75% of the loan amount and the annual premium ranges from 0.45% to 1.05% of the average outstanding loan balance for that year.

You pay annually mortgage insurance premium, or MIP, in monthly installments over the life of the FHA loan if you put less than 10%. If you deposit more than 10%, you pay the MIP for 11 years.

USDA Guarantee Fee

USDA loans are no down payment loans for rural home buyers. Some USDA loans charge two fees: an upfront guarantee fee that you pay once, and an annual fee that you pay each year for the life of the loan. The initial guarantee fee for 2019 is 1% of the loan amount. The annual fee is 0.35% of the average outstanding loan balance for the year, which is broken down into monthly payments and included in your mortgage payment. The federal government assesses the fees each fiscal year and can change them. But the amount of your fees will not fluctuate; it is set at the end of the loan.

VA financing fees

VA mortgages require no down payment and feature low interest rates for serving, disabled or retired military personnel, certain National Guard and Reservist members, and eligible surviving spouses. They don’t need mortgage insurance, but most borrowers will pay a “financing costs“ranging from 1.4% to 3.6% of the loan amount for purchase loans. The fee amount varies depending on the amount of your down payment and whether it is your first VA loan.

How to avoid mortgage insurance

But in general, you will need to get a conventional mortgage and invest at least 20% in a house for avoid mortgage insurance.

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About Clint Love

Clint Love

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