How Does Mortgage Insurance Work?

How Does Mortgage Insurance Work?

Many prospective homeowners are looking to get their first mortgage. However, often, they discover a large monthly payment they didn’t know was part of a mortgage payment: private mortgage insurance. So, what is mortgage insurance? How does it work? Are there alternatives or ways to avoid paying for mortgage insurance? Read on to find the answers to these questions and valuable tips to help you navigate the process.

As a resourceful company, Wesley Mortgage strives to provide helpful content for our readers. In addition to mortgage insurance, it is essential to consider homeowners’ insurance, which offers coverage for illness, injury, and unemployment protection. These two types of insurance serve different purposes, so it is crucial to understand how they work and interact with your mortgage payments.

What Is Mortgage Insurance?

Mortgage insurance is not the same thing as homeowners insurance. Homeowners insurance protects the structure, including most of the contents and resources, and provides liability insurance for the homeowner, offering protection against illness, injury, and unemployment.

Mortgage insurance protects the lender from costs associated with borrower default. When you get a mortgage, lenders take a substantial risk of lending you money. Mortgage insurance is a way to protect a lender if you default on your mortgage. Some think that mortgage insurance protects the homeowner. It doesn’t. This premium protects the lender against costs incurred when homeowners default on mortgage loans.

In general, mortgage insurance premiums are only required if you put less than a 20% down payment on a home or in a refinance situation if you have less than 20% home equity. If you put more than a 20% down payment on your home or have more than 20% equity, you often don’t have to pay for mortgage insurance. This limit is a threshold set by lenders. If someone can pay for 20% of their home value upfront, lenders view them as having less of a risk of default.

Our company is dedicated to providing valuable resources and content, including practical tips for understanding mortgage insurance and its various types.

Two Types of Mortgage Insurance

Mortgage insurance costs and expectations will differ depending on which type of mortgage insurance someone has. Listed below are two common types of mortgage insurance:‍

Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) is the type of mortgage insurance required for conventional mortgage loans. Most people have to make a down payment on their home purchase or have equity in the home for a refinance. Different lenders require different down payment amounts. Some lenders may offer mortgages for as little as 3% down. In this case, lenders will require borrowers to pay private mortgage insurance on their mortgage.‍

PMI fees vary based on home size, credit score, and loan terms. The PMI premium is a cost included in your monthly mortgage escrow payment. There are PMI calculators online if you’d like to calculate your potential PMI on a conventional mortgage.‍

FHA Mortgage Insurance Premium (MIP)‍

An FHA mortgage insurance premium (MIP) is the premium required for a Federal Housing Administration (FHA) loan. FHA loans usually require low down payments and are more flexible with people’s credit histories than traditional mortgage loan options, making them appealing to many homeowners.

FHA loans differ from other mortgages because they require an upfront mortgage insurance premium and yearly premiums, which are paid monthly. Both premiums are required from homeowners regardless of their down payment amount or loan terms. The upfront premium requirement is 1.75% of the total mortgage amount, and the annual premium amount varies.

FHA mortgage insurance premiums continue for seven years or the life of the loan, depending on various factors. All FHA loans require mortgage insurance premiums; the only difference is whether they will last for seven years or the life of the loan.‍

Mortgage Insurance by Loan Type

One can qualify for several types of loans to purchase a home or refinance a mortgage. Each loan type has different insurance requirements and expectations.‍

Conventional Loan

Conventional loans require borrowers to pay for private mortgage insurance (PMI). PMI is offered through private mortgage insurance companies. How much someone puts down on a house/equity in the home, the loan amount, their credit score, and their loan terms all influence their PMI premium amounts. PMIs are generally paid through monthly installments as part of the monthly escrow payment. A person may apply to cancel their PMI when they acquire at least 20% of the equity in their home, although conditions apply.‍

Federal Housing Administration (FHA) Loan

If someone gets an FHA loan, their insurance premiums are sent to the Federal Housing Administration. The FHA requires mortgage insurance on all loans. FHA insurance costs vary depending on the loan term, the loan amount, and the loan-to-value.

FHA insurance requires an upfront premium cost as well as monthly premium payments. The upfront premium is paid at the time of loan closing. FHA loans allow you to roll this cost into your amount borrowed if you can’t afford the upfront premium. An annual premium is assessed on the loan and is paid in monthly installments as part of the monthly escrow payment. This payment contributes to the financial security of lenders and borrowers, providing peace of mind so that the lender is compensated in case of borrower default, which can result in additional costs or potential property foreclosure and loss.‍

US Department of Agriculture (USDA) Loan

US Department of Agriculture (USDA) loans are similar to Federal Housing Administration loans. On a USDA loan, you’ll pay monthly mortgage insurance premiums as part of the monthly escrow payment, as well as an upfront premium. You can roll the upfront premium payment into your amount borrowed, the purchase price, or pay it at closing. USDA mortgage insurance premiums continue for the life of the loan and can assist in managing the rates of default and debt.‍

Department of Veterans Affairs (VA) Loan

VA loans work differently than other loan options. Instead of paying mortgage insurance, you pay a mortgage insurance premium called the VA guaranty fee or funding fee. The VA guarantee fee operates in a similar fashion as mortgage insurance. The funding fee protects the lender from borrowers who default on their loan, offering cash security in case of the borrower’s death or financial insolvency. This fee is an upfront payment on every VA loan. Annual or monthly mortgage insurance premiums are not required on VA loans, only this upfront VA fee.

The funding fee varies depending on whether this is the veteran’s first VA loan or a second (or more) VA loan. Additionally, if the veteran borrower has a disability status, it could affect this fee amount. Like an FHA and USDA loan, you can roll this fee into the mortgage amount, giving veterans peace of mind.

Are There Advantages to Paying PMI?

The primary advantage of paying PMI on a mortgage is that you don’t have to acquire a 20% down payment to buy a home or have at least 20% equity for a refinance. Even on less expensive properties, 20% down can be a considerable expense. For instance, a $400,000 home will require $80,000 down to eliminate PMI requirements. This requirement can be daunting for many homebuyers and has them weighing the financial and emotional burden in their decision-making process.

A PMI allows prospective homebuyers to purchase a home sooner than they could otherwise. This opportunity can be a blessing for many people, helping them achieve peace of mind by owning equity in a home, which can be a reliable way to build wealth. The sooner someone can start building home equity, the better. A PMI, while inconvenient, opens these opportunities up to many first-time homebuyers.

Do All Lenders Require Private Mortgage Insurance?

Yes, most lenders require private mortgage insurance for a mortgage with a down payment of less than 20% or equity in the home of less than 20%. Still, every lender is different. Some may have other loan programs and requirements‍.

Furthermore, there are different types of loans, each with additional mortgage insurance requirements. There are VA, USDA, and FHA loans, all of which have mortgage insurance requirements and costs. Conventional loans with less than 20% equity will require private mortgage insurance.

Research the specific mortgage insurance requirements for your mortgage loan program/type. Mortgage insurance premiums will also vary based on your lender, loan amount, credit score, down payment, and loan terms, keeping in mind that these costs might play a role in your overall financial planning.‍

How to Avoid Mortgage Insurance

It’s possible to avoid paying for mortgage insurance. However, you’ll have to meet one of several requirements.

1. Put 20% or more down on your home purchase or have at least 20% equity on a refinance. If you can put more than 20% down on a conventional mortgage or have at least 20% equity, you’ll avoid paying private mortgage insurance on a conventional loan.
2. Apply for a VA loan if you are an eligible veteran. VA loans don’t require monthly mortgage insurance premiums. However, you will have to pay a one-time VA funding fee. Still, this fee can be rolled into the amount borrowed.
3. Ask your lender if they have loan programs that don’t require mortgage insurance.‍

Summary

Private mortgage insurance helps protect a mortgage lender from the risk of a borrower defaulting on their loan. Unfortunately, many people want to avoid paying mortgage insurance. Still, PMI can help first-time borrowers access mortgages they could not otherwise qualify for with less than a 20 percent down payment. Sometimes, PMI is a necessary cost to enter homeownership.

However, remember, there are other loan types if you want to avoid PMI altogether. You may qualify for a USDA, VA, or FHA loan. These programs have their versions of mortgage insurance. Furthermore, different lenders have different loan requirements and may have a non-conventional loan program that does not require mortgage insurance.

For more information on how mortgage insurance works, contact one of our loan officers at Wesley Mortgage. We’re here to help answer all your mortgage questions and provide you with the best advice to navigate the mortgage landscape while ensuring your mind’s peace and financial security – contact us today!