- Mortgage insurance is a type of insurance that protects the mortgage lender in case a borrower defaults.
- Private mortgage insurance is required on conventional loans when the borrower puts down less than 20%.
- FHA loans also require mortgage insurance, both upfront and monthly.
Low-down-payment mortgages have made buying a home more achievable for cash-strapped borrowers. Today, many borrowers are able to get into a home with as little as 3% down.
But these low down payments come with a cost: Mortgage insurance. Mortgage insurance is designed to protect the lender if you fail to make payments — and it adds costs to your monthly payment and, sometimes, to your closing fees, too.
Here's what to know about mortgage insurance before you apply for a loan.
Types of mortgage insurance
The type of mortgage insurance you'll need depends on your loan program. The main types include:
Private mortgage insurance (PMI)
Private mortgage insurance (PMI) is a type of mortgage insurance added to a conventional mortgage when the borrower makes a low down payment. If you get a conventional mortgage and put down less than 20%, you'll be required to pay for PMI until you reach at least 20% equity in your home.
PMI is also required if you're refinancing and have less than 20% equity in your home.
Conventional mortgages, which are the most common type of mortgage and what most people think of as "traditional" mortgages, don't come with any government backing. This means if the borrower defaults on their loan, the mortgage lender doesn't receive funds from a government agency to recoup its losses.
Borrowers who make large down payments typically are at less of a risk of defaulting on their mortgages, since they have a larger financial stake in the home. And if they do default, the lender has less to lose than with a borrower who has very little equity in their home.
To protect themselves on loans where the borrower has made a small down payment, mortgage lenders require borrowers to pay for private mortgage insurance, which will pay out to the lender if the borrower defaults on their mortgage.
"The greatest benefit to PMI is the homeownership attainability it creates," says Raul Hernandez, a mortgage broker with Competitive Home Lending. "Prior to PMI, potential homebuyers would need to save for a 20% down payment in order to qualify for a home loan."
With PMI, you can cancel your coverage once you reach 20% equity in the home (meaning your loan balance is 80% or less than your home's value).
Mortgage insurance premium (MIP)
FHA MIP is paid both upfront and as part of your monthly mortgage payment toward an annual premium. All FHA loan borrowers pay an upfront fee equal to 1.75%. This can be paid at closing or rolled into your loan amount. Annual MIP ranges from 0.15% to 0.75% of the loan amount.
The downside of FHA mortgage insurance is that most borrowers are required to pay it for the life of the loan. If you make a 10% down payment, though, you may be able to cancel it after 11 years.
VA funding fee
The VA loan program's version of "mortgage insurance" is its one-time funding fee that helps pay for the program. VA borrowers are required to pay this fee unless they meet certain criteria, which includes receiving compensation for a service-connected disability.
The VA funding fee, like FHA's upfront MIP, can be paid at closing or financed into the loan. The amount you'll pay depends on the type of loan you're getting, how much you put down, and whether you've used the program before. The typical borrower using a VA loan for the first time to purchase a home with 0% down will pay a funding fee equal to 2.15% of the loan amount.
USDA guarantee fee
Like the VA funding fee, the USDA loan guarantee fee isn't technically mortgage insurance but rather helps cover the cost of the U.S. Department of Agriculture's guarantee, which promises lenders that it will cover up to 90% of the loan amount if a borrower defaults. This is what enables USDA loan lenders to offer these mortgages with no required down payment.
The upfront guarantee fee is equal to 1% of the loan amount and can be paid upfront or rolled into your mortgage. The annual USDA guarantee fee is equal to 0.35% of the loan amount.
How mortgage insurance works
Mortgage insurance is a lender-side protection, compensating the company if you default on your loan. Here's what to know about how these policies work:
Monthly premiums
With PMI, you'll pay a monthly premium for your policy. Freddie Mac estimates this costs between $30 to $70 per month for every $100,000 you borrow.
MIP is paid both as an upfront fee and then annually. Your annual cost is divided by 12 and spread across your monthly mortgage payments.
Cancellation
The good news is that even if you make a low down payment, PMI won't stick around forever. Once you reach 20% equity in your home, you can ask your mortgage lender or servicer to remove PMI from your monthly mortgage payment. Otherwise, it will drop off automatically when you reach 22% equity.
With an FHA loan, you'll typically pay MIP throughout the life of the loan. If you want to get rid of mortgage insurance on an FHA loan, you might consider refinancing into a conventional loan once you have 20% equity in your home.
Cost of mortgage insurance
Mortgage insurance costs can vary quite a bit. Here's what determines them:
Factors influencing the cost
PMI rates can vary depending on your creditworthiness and your mortgage.
"As with a mortgage loan, the premium for PMI is based on individual loan applications," Hernandez says. "Factors such as debt-to-income, loan-to-value, credit score, and even the number of applicants on a home loan can determine the annual PMI rate."
Your credit score is one of the main factors that will influence how much you end up paying for PMI, and those with low scores will typically have the highest mortgage rates. This is why getting an FHA mortgage is often a better option for those with poor scores; according to the Urban Institute, a borrower who puts down 3.5% and has a credit score below 720 will pay less each month on an FHA mortgage than a conventional mortgage with PMI.
Another factor that can impact your PMI costs is your down payment. If you make a larger down payment, such as 10% or 15%, you'll likely have a lower PMI rate. Insurers will also likely consider your debt-to-income ratio (DTI), which tells them how much of your monthly income is spent on debt payments, including a mortgage.
PMI
PMI costs range widely, and the exact amount you'll pay depends on your loan amount, down payment size, and credit score. Typically, you can expect to pay $30 to $70 per month for every $100,000 borrowed. On a $400,000 loan, that would mean somewhere between $120 and $280 per month for PMI.
MIP
How much you'll pay for your annual FHA mortgage insurance premium depends on your loan amount, mortgage term, and the size of your down payment and ranges from 0.15% to 0.75% of the loan amount. The upfront MIP fee is 1.75% of your initial loan amount.
How to avoid or minimize mortgage insurance
Mortgage insurance isn't always a given. Here are some ways you can avoid it — or, at the very least, reduce what you have to pay.
Make a 20% down payment
The easiest way to avoid mortgage insurance is to make a down payment of at least 20% on a conventional loan.
Keep in mind, though: Just because you have the funds to put 20% down doesn't always mean you should. If you have a great credit profile, PMI might not be that big of an expense, and it could enable you to put that savings into an investment account where it can earn you money. You also want to be careful about draining your savings for a down payment, since you'll likely need that money for home maintenance and repairs.
Consider lender-paid mortgage insurance
Not all mortgage insurance is paid for by the borrower. Depending on where you get your mortgage, you may be able to negotiate lender-paid insurance. Just be ready: These options come with higher interest rates to account for the lender's extra costs.
Improve your credit score
A higher credit score can often qualify you for a lower PMI rate, as it indicates you're at a lower risk of defaulting on your loan. You can improve your credit score by paying down your debts and staying on top of your bills.
Refinance
Refinancing can also help you avoid PMI, depending on your loan program. If you have an FHA loan, for instance, you may opt to refinance into a conventional loan once your balance reaches 80% or less than your home's value. This would allow you to take out a new loan without PMI from the start.
Mortgage insurance FAQs
Yes, you'll need mortgage insurance if you make a down payment under 20% in most cases.
If you have a conventional loan, you can request that your insurance be canceled once you reach 20% equity in the home. If you have an FHA loan, you'll likely need to refinance to get rid of mortgage insurance.
If you're getting a standard conventional mortgage with a down payment below 20%, you'll generally always need to pay for private mortgage insurance. Some lenders offer conventional mortgage products that allow low down payments without PMI, but be aware that these loans often come with higher interest rates.
No, you can no longer deduct mortgage insurance premiums on your taxes. Mortgage insurance used to be tax deductible, but the deduction has now expired, according to the IRS.
