Buying a home is one of the biggest financial commitments most people make, and mortgage insurance is often a necessary part of the process.
While the idea of paying for insurance on top of your mortgage may not sound appealing, mortgage insurance plays an important role in protecting both the lender and, in some cases, the borrower.
1. What is mortgage insurance?
Mortgage insurance is a type of insurance policy that protects the lender if the borrower defaults on their home loan. It is typically required for borrowers who put down less than 20% when purchasing a home.
By requiring mortgage insurance, lenders reduce the risk of losing money if a borrower is unable to make payments.
2. Types of mortgage insurance
There are different types of mortgage insurance, depending on the type of loan you have. The two most common types are private mortgage insurance (PMI) and mortgage insurance premiums (MIP), which apply to conventional and FHA loans, respectively.
- Private mortgage insurance (PMI): PMI is required for conventional loans when the borrower puts down less than 20%. The cost of PMI is typically added to the monthly mortgage payment, and once the borrower reaches 20% equity, they can request to cancel PMI.
- Mortgage insurance premium (MIP): MIP applies to FHA loans, which are backed by the Federal Housing Administration. Unlike PMI, MIP is required for the life of the loan unless the borrower makes a down payment of at least 10%. In this case, the MIP can be canceled after 11 years.
3. How much does mortgage insurance cost?
The cost of mortgage insurance varies based on factors like the size of your down payment, the loan amount, and the type of insurance.
For PMI, the cost generally ranges from 0.5% to 1% of the original loan amount per year. For example, if you have a $200,000 mortgage, PMI could cost between $1,000 and $2,000 annually, or about $83 to $167 per month.
MIP costs for FHA loans include both an upfront premium, which is typically 1.75% of the loan amount, and an annual premium that ranges from 0.45% to 1.05%, depending on the loan term and amount.
4. How to avoid mortgage insurance
The best way to avoid paying mortgage insurance is to make a down payment of at least 20% when purchasing a home.
If saving for a large down payment isn’t feasible, you can explore other options, such as:
- Piggyback loans: With a piggyback loan, you take out a second loan to cover part of the down payment, typically in the form of a home equity loan. This allows you to avoid PMI but comes with additional loan payments.
- Lender-paid mortgage insurance (LPMI): Some lenders offer LPMI, where the cost of mortgage insurance is built into the interest rate. While this option avoids a separate insurance payment, it may result in a higher interest rate overall.
5. When can you cancel mortgage insurance?
For conventional loans with PMI, you can request to cancel the insurance once you’ve reached 20% equity in your home. Lenders are required to automatically cancel PMI once you reach 22% equity, as long as you’re current on your payments.
FHA loans with MIP generally don’t allow for cancellation unless the borrower made a 10% or higher down payment. In those cases, the MIP can be removed after 11 years. Otherwise, the MIP remains for the life of the loan.
Mortgage insurance is an added expense, but it plays a vital role in helping homebuyers secure loans with smaller down payments.
By understanding the different types of mortgage insurance, how much it costs, and when it can be canceled, you can make informed decisions and potentially save money over time.
If you’re preparing to buy a home, consider how mortgage insurance might impact your monthly payments and explore ways to avoid or reduce the cost.