What Is Mortgage Insurance?
For most of the 20th century, a 20% down payment was standard when buying a home. As a homebuyer, you would pay 20% of the purchase price from your savings and finance the remaining 80% with a conventional mortgage loan.
However, as home prices continue to rise, more buyers are looking for ways to buy a home with a lower down payment amount. And mortgage insurance makes this possible. With mortgage insurance, well-qualified buyers can purchase a home with as little as 3% down. Some buyers may even qualify for less if they meet the criteria for certain down payment assistance programs.
In this article, you’ll get answers to some of the most common questions about mortgage insurance, including:
- What is mortgage insurance?
- What are the different types of mortgage insurance?
- How much does mortgage insurance cost?
- Can mortgage insurance be avoided or terminated?
Mortgage Insurance Defined
Mortgage insurance is a financial product that protects the mortgage lender if the borrower defaults on the loan. This allows lenders to take on riskier loans, including loans in which the borrower puts down less than 20% of the purchase price. These loans are riskier for lenders because the homebuyer has less equity (ownership stake) in the home.
It’s important to note that home loans are secured by the home itself. This means that failing to repay the mortgage loan can result in foreclosure, in which the lender seizes possession of the property. But lenders do not want to foreclose on homes. The foreclosure process is time-consuming and expensive for lenders. Mortgage insurance helps to compensate the lender for their lost interest payments and administrative expenses if a borrower fails to repay their home loan.
So, the purpose of mortgage insurance is to make homeownership more accessible for homebuyers by mitigating the risk for the lender. This allows the lender to offer home loans to borrowers with lower down payments.
Types of Mortgage Insurance
Different types of mortgage insurance are available, depending on the borrower's financial circumstances and chosen home loan type.
Private Mortgage Insurance (PMI) is the type of mortgage insurance that applies to conventional loans (any home loan that is not backed by the federal government) with a down payment of less than 20%. Conventional loans with PMI allow borrowers with exceptional credit and strong financials to qualify for a home loan with a down payment of as little as 3% of the purchase price.
There are multiple categories of PMI to help a wide range of buyers.
Borrower-Paid PMI (BPMI)
Borrower-paid PMI is the most common form of mortgage insurance. With BPPMI, borrowers pay a monthly premium to cover the cost of the insurance policy. This amount is added to your monthly mortgage payment, allowing you to include the PMI payment with your mortgage payment, rather than making separate payments.
Single-Premium Mortgage Insurance (SPMI)
Single-premium mortgage insurance is paid with a one-time, upfront premium due at closing.
Split-Premium Mortgage Insurance
Split mortgage insurance is a hybrid of BPMI and SPMI, allowing borrowers to pay a portion of the mortgage insurance premium upfront and the remainder in monthly installments.
With lender-paid PMI, the lender charges a higher interest rate on the home loan to cover the insurance premiums rather than having the borrower pay the premiums directly.
2. FHA Mortgage Insurance Premiums (MIP)
FHA mortgages are the most popular options of the available government-backed mortgages. This means that the federal government (the Federal Housing Administration, in the case of FHA loans) guarantees the loan. If the borrower fails to repay the loan, the government would step in to compensate the lender.
The government offers this type of backing to make homeownership more accessible. By guaranteeing the loan, the lender is able to take greater risk and extend financing to those who might not otherwise qualify for a conventional loan.
FHA loans were designed to help first-time buyers by creating a path to homeownership with low down payments, low closing costs, and easier credit score qualifying. Today, homebuyers can qualify for an FHA loan with as little as 3.5% down with flexible credit score requirements. It is also possible to qualify with a lower credit score if you can make a down payment of 10% or more.
In exchange for these low down payments and relaxed credit requirements, the FHA requires its own form of mortgage insurance called Mortgage Insurance Premium. Importantly, all FHA mortgages require MIP, regardless of the size of the downpayment. MIP requires an upfront fee, equal to 1.75% of the loan amount, plus annual fees, which vary based on the loan term and loan amount.
3. VA Loan Funding Fee
VA loans are backed by the Department of Veterans Affairs and are available only to military service members, veterans, and their spouses. These loans offer 0% down payment options to qualified homebuyers.
VA loans do not require PMI or MIP. Instead, an upfront funding fee, equal to 1.5% of the loan amount, serves a similar purpose as mortgage insurance for buyers who put less than 5% down. This fee allows the VA to continue offering favorable mortgage terms to make homeownership accessible to those who serve.
4. USDA Loan Guarantee Fee
The U.S. Department of Agriculture (USDA) offers mortgage loan guarantees to incentivize homeowners to live in more rural areas. USDA loans are available to low-to-moderate-income buyers who purchase qualified homes in designated eligible areas.
USDA loans offer 0% down payment options for qualified buyers in exchange for a guarantee fee, which is paid in an upfront payment plus annual payments, and serves the same purpose as mortgage insurance.
How Much Is Mortgage Insurance and How Is Mortgage Insurance Calculated?
The specific premium rates can vary between different insurers and loan programs, but here are some guidelines:
- Conventional PMI: The cost of PMI varies from one borrower to the next. The amount depends on several factors, such as the loan amount, the down payment amount, and the borrower's credit score. For reference, the average cost of PMI ranges from 0.58% to 1.86% of the original loan amount per year. At those rates, PMI on a $400,000 home with a 3% down payment would cost $2,250 to $7,217 per year or $187.50 to $601 per month. In general, the higher your home equity and the higher your credit score, the lower your PMI premiums.
- FHA MIP: This premium comes to 1.75% of the loan amount. It can be paid upfront or rolled into the loan and paid in monthly installments.
- VA Funding Fees: This fee is currently 2.3% of the loan amount for first-time purchases using VA financing and 3.6% for subsequent VA purchases by the same buyer. With a down payment between 5% and 10%, the fee is 1.6% (regardless of whether this is a first purchase or subsequent purchase), and with a downpayment of 10% or more, the fee is 1.4%. However, this fee may be waived for special circumstances, such as when the borrower receives VA compensation for a service-connected disability.
- USDA Loan Guarantee: This fee is currently 1% of the loan amount upfront plus .35% of the loan amount annually. These fees can be rolled into your mortgage payment, allowing you to pay in monthly installments.
How Long Do You Pay Mortgage Insurance?
The duration of mortgage insurance payments depends on the loan program and the specific terms of the mortgage agreement.
For conventional loans with PMI, mortgage insurance is typically required until the borrower pays down the loan enough so that they have at least 20% equity in the home. At this point, borrowers can request the cancellation of PMI.
For government-backed loans, the respective mortgage insurance for each loan type is generally required for the life of the loan. If you wish to remove the mortgage insurance expense, you could consider refinancing your mortgage to a conventional loan once you reach 20% equity. This would mean replacing your original home loan with a new conventional loan.
Is Mortgage Insurance Refundable?
Mortgage insurance may be refundable under certain circumstances. The specific rules and requirements for PMI refunds vary between lenders and loan programs, so it is important to discuss your options with a mortgage loan expert. However, mortgage insurance premiums for FHA loans, funding fees for VA loans, and guarantee fees for USDA loans are generally non-refundable.
The Bottom Line
Mortgage insurance makes it possible for homebuyers to purchase a home without a 20% down payment. With so many loan programs available, it is worth discussing your options with a qualified home loan expert. Contact a PNC Bank Mortgage Loan Officer today for a free consultation.