Mortgage Insurance Requirements for a Conventional Loan

May 31, 2023 | Mortgage Guides

Understanding Conventional Loan PMI: What You Need to Know

Many individuals take out a conventional loan to finance their home purchase. Understanding mortgage insurance requirements is crucial when considering a conventional loan. Private Mortgage Insurance (PMI) is typically required when a borrower puts down less than 20% of the home’s purchase price. 

PMI protects lenders in case of default, but it also adds an additional monthly cost for the borrower. The amount of PMI can vary based on the loan amount, the down payment size, and the borrower’s credit score. 

This article will delve into the specifics of mortgage insurance requirements for conventional loans, explaining how PMI works, when it can be canceled, and tips for minimizing PMI costs. By comprehending these factors, you can make informed decisions and potentially save money on your home loan.

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What is Mortgage Insurance

Mortgage insurance protects lenders in case a borrower defaults. It can help borrowers qualify for a loan.

Types of Mortgage Insurance

Two insurances are available: private mortgage insurance (PMI) and government-backed (FHA).

PMI is offered by private companies, while FHA insurance is provided by the Federal Housing Administration (FHA). 

PMI is required for borrowers with a down payment of less than 20%, while FHA insurance is required if the down payment is less than 3.5%.

Mortgage insurance can be paid in a lump sum or added to the mortgage. 

Cost of Mortgage Insurance

The cost of mortgage insurance depends on various elements, including the loan amount, the down payment, and the borrower’s credit score. A conventional loan requires private mortgage insurance (PMI) when the loan-to-value ratio is greater than 80%. The following are some factors that affect the rate:

  • Loan amount: The higher the amount, the higher the cost.
  • Down payment: The lower the down payment, the higher the cost.
  • Credit score: Borrowers with lower credit scores will pay more.
  • Loan type: The type of loan can also affect the rate. For example, FHA loans have higher premiums than conventional loans.
  • The type of property being purchased can also affect the rate. For instance, if the property is a condominium, the insurance might be higher. 
  • Other factors that can impact the cost include the loan term, the size of the loan, and the borrower’s debt-to-income ratio.

Loan-to-value ratio (LTV)

Loan-to-value ratio (LTV) is a term used to describe the proportion between the amount of money borrowed and the value of the asset being purchased. In the context of a mortgage, the LTV ratio is calculated by dividing the loan amount by the appraised value of the property. 

LTV ratios estimate a loan’s risk. A higher LTV ratio indicates a greater gamble, as the borrower has less equity. This means that if the borrower defaults, the lender may have difficulty recouping its losses.

Lenders set maximum LTV ratios for various loans. For example, a conventional mortgage may have a maximum ratio of 80%, while a government-backed loan may have a maximum of 95%. If you are considering taking out a mortgage, it is important to understand the LTV ratio and how it will affect the loan terms. 

Pros and cons 

Benefits of Mortgage Insurance

  • PMI can help you get approved for a mortgage. It is required for borrowers who put down less than 20% of the purchase price of a home, so you can qualify even without a large down payment.
  • This protects the creditor. If you default, the lender will collect on the insurance instead of foreclosing on the property.
  • Gives you peace of mind. Knowing that the mortgage is insured is beneficial if something prevents you from making the payments.

Disadvantages of mortgage insurance

  • Adds to the price of a mortgage. PMI is often added to your payment, which can increase your overall cost of homeownership.
  • It can be difficult to cancel. Once you have PMI, it can be difficult to get rid of it, even if the equity in your home increases.
  • It can be expensive. The cost of PMI can vary depending on the lender and the type of loan, but it can add hundreds of dollars to the bills.

Canceling Mortgage Insurance

Borrowers can cancel the insurance once they have reached 20% equity. 

Equity is the difference between the value of the home and the amount owed on the loan. To calculate equity, use the following formula: 

Equity = Market Value of Home – Loan Balance

Here are some tips for canceling your mortgage insurance:

  • Make sure you have reached 20% equity in your home.
  • Contact your lender to request cancellation of the mortgage insurance.
  • Provide the lender with an appraisal of your home.
  • Be prepared to pay outstanding premiums.

Alternatives to PMI

  • Government-backed mortgage insurance: There are two: FHA and VA. 
    • FHA mortgage insurance is available to borrowers with down payments as low as 3.5%, while 
    • VA mortgage insurance is available to veterans and active-duty military personnel with no down payment required.
  • Down payment assistance programs: Numerous down payment assistance programs are available through state and local governments, as well as through nonprofit organizations. These programs can help borrowers with the upfront costs of buying a home, including the down payment and closing costs.
  • Borrowing from relatives: If you have family or friends who can lend you money for a down payment. Just get everything in writing, including the terms of the loan, such as the interest rate and repayment schedule.
  • Saving for a larger down payment: This may seem like the obvious solution. The larger your down payment, the less you need to borrow and the lower the mortgage payments will be.

Conclusion

Mortgage insurance is a policy that protects lenders in case borrowers default on their mortgages. Whether it is appropriate depends on individual circumstances, albeit it is required when the down payment is less than 20% of the home’s purchase price. 

If you’re uncertain about getting mortgage insurance, talk to a financial advisor.

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