When securing a mortgage loan, many borrowers encounter the term “mortgage insurance.” While it may seem like an additional cost, mortgage insurance plays an important role in helping you become a homeowner, especially if your down payment is less than 20%. Understanding the key terms associated with mortgage insurance is essential to making informed financial decisions. This article will guide you through the different types of mortgage insurance, how they work, and what you should know as a borrower.
Key Takeaways :
- Types of Mortgage Insurance: The two main types of mortgage insurance are Private Mortgage Insurance (PMI) for conventional loans and government-backed mortgage insurance for FHA, VA, and USDA loans, each with different guidelines and costs.
- Cost and Duration: Mortgage insurance costs vary based on loan type, down payment, and loan amount. PMI can be canceled once you reach 20% equity, but FHA mortgage insurance may last for the life of the loan unless specific conditions are met.
- Avoiding Mortgage Insurance: You can avoid mortgage insurance by making a larger down payment (at least 20%), opting for a no-MI loan, or using a piggyback loan to cover part of the down payment.
What is Mortgage Insurance?
- Mortgage insurance is designed to protect the lender in case the borrower defaults on the loan. If you put down less than 20% of the home’s purchase price, lenders consider the loan riskier. Mortgage insurance helps mitigate this risk, ensuring that lenders can recover some of their losses if a borrower fails to repay.
Types of Mortgage Insurance
- There are two primary types of mortgage insurance: private mortgage insurance (PMI) and government-backed mortgage insurance. Each serves a different purpose and is applicable to different types of loans.
- Private Mortgage Insurance (PMI):
PMI is typically required for conventional loans when the borrower’s down payment is less than 20%. This type of insurance protects the lender, not the borrower. The cost of PMI can vary depending on the size of the down payment and the loan amount. PMI can be paid monthly as part of your mortgage payment, as a lump sum at closing, or as a combination of both. - Government-Backed Mortgage Insurance:
Certain government-backed loans, such as FHA loans (Federal Housing Administration), VA loans (Veterans Affairs), and USDA loans (U.S. Department of Agriculture), require mortgage insurance for borrowers who don’t meet standard down payment requirements. While PMI is for conventional loans, government-backed mortgage insurance has different guidelines and premiums based on the loan type.
- FHA Loans: These loans require mortgage insurance premiums (MIP) for the life of the loan, regardless of the down payment amount. The upfront MIP is typically rolled into the loan amount, and the annual MIP is included in your monthly payments.
- VA Loans: Veterans and active military members may qualify for a VA loan, which does not require traditional mortgage insurance. Instead, a funding fee is charged, which can be financed into the loan.
- USDA Loans: These loans also require mortgage insurance, which is typically more affordable than PMI. USDA mortgage insurance is called a guarantee fee, and it is divided into an upfront fee and an annual fee.
How Much Does Mortgage Insurance Cost?
The cost of mortgage insurance varies based on several factors, including the type of loan, the size of your down payment, and the loan amount.
- PMI Costs: PMI typically ranges from 0.3% to 1.5% of the original loan amount per year. For example, on a $200,000 loan, PMI could cost anywhere from $600 to $3,000 annually.
- FHA MIP Costs: For FHA loans, MIP typically costs 1.75% of the loan amount upfront and can range from 0.45% to 1.05% annually based on the size of the loan and the length of the term.
- VA Funding Fee: VA loans require a funding fee that ranges from 1.4% to 3.6% of the loan amount, depending on the borrower’s down payment and military service status.
- USDA Guarantee Fee: The upfront guarantee fee for USDA loans is 1% of the loan amount, and the annual fee is 0.35%.
How Long Do You Need Mortgage Insurance?
- The length of time mortgage insurance is required depends on the type of loan and the size of your down payment. For conventional loans, PMI can usually be canceled once you reach 20% equity in your home. You can request PMI cancellation after your loan balance reaches 80% of the original appraised value, or the lender may automatically cancel PMI when you reach 78% loan-to-value (LTV).
However, for FHA loans, mortgage insurance typically remains in place for the life of the loan if your down payment is less than 10%. If your down payment is greater than 10%, you can cancel MIP after 11 years.
Also Read : Exploring Different Types of Insurance: How They Protect You