Mortgage insurance is a type of insurance that protects against default on home loans. Because private mortgage insurance (PMI) mitigates risk to the investors who own mortgages, it allows folks with down payments less than 20% to purchase a home.
This, in addition to other measures taken by lenders, such as including a mortgagee clause within your homeowners insurance policy, all help to protect mortgage investors.
Generally, if you put less than 20% down on a home, most conventional lenders will require you to purchase PMI.
A conventional loan is a loan that isn’t backed by the federal government.
Mortgage insurance is an additional monthly expense you’ll need to consider.
Your lender will likely include your PMI expense in your monthly mortgage payment automatically.
The lender oversees selecting the mortgage insurance company, so you won’t be able to shop around, but you can ask for a quote before you finalize your paperwork.
How Mortgage Insurance Works
Mortgage insurance protects mortgage lenders by compensating their losses when borrowers fail to repay in certain conditions, such as default or death, depending on the policies.
The premium and coverage of mortgage insurance are determined by the value of the borrowed amount.
The premium is typically a percentage of the loan value. It is integrated into the monthly payments for the loan.
The coverage of mortgage insurance falls as the mortgage does since the principal and interest are gradually repaid by the borrower.
When mortgage insurance is purchased, a master policy is issued to the beneficiary, which is a bank or another mortgage lender entity.
A master policy specifies how the default should be notified when the coverage is applied or denied, and other conditions.
It usually requires the exclusion of misrepresentation, fraud, and negligence.
In the aftermath of the 2008 subprime mortgage crisis, the master policy of mortgage bonds is now scrutinized more closely.
What’s The Cost Of Mortgage Insurance?
Mortgage insurance costs depend on the type of insurance you have. On average, you can expect to pay 0.5 – 1% of your home loan amount annually with PMI.
Your premiums for PMI will depend on:
- Your PMI type
- Whether the interest rate is fixed or adjustable
- The length of your home loan, also known as your mortgage term
- Your loan-to-value (LTV) ratio
- The insurance coverage amount required by your lender
- Your credit score
- Your home’s value
- Whether the premium is refundable
- Additional risk factors, which will be determined by your lender
For instance, if you have a low credit score and only put down a 3% down payment, you’ll likely pay a higher amount for your mortgage insurance than a buyer with a better credit score who put down more money on the same home.
Private Mortgage Insurance
Private mortgage insurance (PMI) is the most common type of mortgage insurance. It is provided by private insurance companies. The policies on PMI vary in different countries.
In the U.S., a lender typically requires the home buyer to purchase PMI if the down payment is lower than 20% of the property in the case of a conventional mortgage (not backed by the federal government).
It enables a borrower who cannot meet the 20% down payment to buy a house and simultaneously protects the lender from the losses of default.
If the borrower makes a down payment or holds an equity position of at least 20%, which means the loan-to-value ratio is equal to or smaller than 80%, he can ask the lender to remove PMI.
A borrower does not need to pay for PMI for the entire mortgage term. According to the U.S. Homeowners Protection Act of 1998, a borrower can request to cancel PMI when the repayment reaches the sales price or 78% of the original appraised value, whichever comes first.
PMI can be further divided into borrower-paid private mortgage insurance (BPMI) and lender-paid private mortgage insurance (LPMI). BPMI is the more common type.
A lender usually charges a higher interest rate in the case of LPMI to compensate for the insurance premium.
Qualified Mortgage Insurance
The Federal Housing Administration (FHA) requires qualified mortgage insurance from its borrowers.
The FHA bears high default risks, as the ones who are not qualified for a conventional mortgage loan can borrow from the FHA.
The federal agency accepts borrowers with credit scores as low as 500 and down payments as low as 3.5%.
Hence, every borrower who takes an FHA mortgage must purchase qualified mortgage insurance, regardless of the value of the down payment.
Qualified mortgage insurance has different premium rates and cancellation policies from PMI.
Borrowers, even those who are qualified for a conventional mortgage loan, should consider an FHA mortgage to see which one is more favorable.
Mortgage Life Insurance
Different from mortgage loan insurance, which protects lenders in the case of default, mortgage life insurance protects the heirs or the lenders when borrowers die while carrying loans.
If a borrower is concerned that his accidental death will leave a large amount of mortgage to his family, the borrower can purchase mortgage life insurance.
The coverage can be paid either to the lenders or to the heirs specified in the insurance policy.
Although both pay coverage in the case of the insured’s death, mortgage life insurance should not be confused with personal life insurance.
The coverage of mortgage life insurance can only be used to pay back the mortgage balance.
Thus, the amount of coverage declines due to amortization.
Conversely, personal life insurance does not limit how the beneficiaries can use the coverage.
The coverage amount of personal life insurance does not usually decrease.
How Is Mortgage Insurance Calculated?
Lenders will calculate your PMI premium rate, generally 0.5 – 1%, based on several factors to determine risk.
These factors include your credit score, down payment amount and existing loans.
The mortgage insurer will tell you what your premium will cost.
If you want to make a conservative estimate before applying for a loan, it’s best to expect a 1% rate.
Your premium will be recalculated every year as you pay off your principal, so expect it to decrease with time.
Let’s say you put 5% down on a $200,000 home, leaving you with a $190,000 conventional loan.
If the mortgage insurance company is charging you 1%, your annual PMI payment is $1,900.
Your lender will likely consolidate the monthly PMI fee of $158.33 along with your mortgage payments.
You can also use our mortgage calculator to get an estimate that includes property taxes, homeowners insurance and mortgage interest.
In addition, you may want to include any expenses from mortgage protection insurance. This helps borrowers and their families cover their mortgage, in the event payments can’t be made.
Though it’s not required, it may be an additional expense you’ll want to account for when estimating monthly payment costs.
Different Types Of Mortgage Insurance?
There are three different types of mortgage insurance you should be aware of. Here’s a quick overview of each type.
1. Borrower-Paid Mortgage Insurance
In most cases, your PMI will be borrower-paid mortgage insurance (BPMI). When lenders talk about PMI, this is usually the type they’re referring to.
BPMI is the type of mortgage insurance that’s rolled into your monthly mortgage payment.
Let’s break down how it could affect your costs. Typically, you’ll pay about .5 – 1% of your loan amount per year for PMI.
This translates to $1,000 – $2,000 per year in mortgage insurance, or about $83 – $166 per month.
You can cancel the insurance after you have paid more than 20% of the home’s value.
For single-family homes, this occurs when you have reached 78% LTV ratio, which means you have paid off 22% of the value of the loan, or when you’ve reached the midpoint of your loan term – that’s 15 years for a 30-year mortgage.
2. Lender-Paid Mortgage Insurance
Lender-paid mortgage insurance (LPMI) means your lender initially pays your mortgage insurance, but your mortgage rate is higher to compensate for that lender payment.
The interest rate increase is typically .25 – .5% more for LPMI. You’ll save on monthly payments and you’ll have a lower down payment because you’re not required to have 20% down with LPMI.
The lower your credit score, the higher your interest rate will be. LPMI will cost you more if you have a low credit score.
Also, you’ll never be able to cancel LPMI because it’s built into your payment schedule for the entire loan term.
3. FHA Mortgage Insurance Premium
We’ve covered the types of mortgage insurance options for conventional loans, but what about government-backed home loans? Most FHA home loans, which are first-time home buyer loans financed through the federal government, also require the purchase of mortgage insurance, called a mortgage insurance premium (MIP).
In most cases, you pay mortgage insurance for the duration of your loan term unless you make a down payment of 10% or more (in which case, MIP would be removed after 11 years).
You’ll need to pay a couple of ways. First, an FHA loan upfront mortgage insurance premium (UFMIP), which is usually about 1.75% of your base loan amount.
Next, you’ll also pay an annual mortgage insurance premium. Annual MIP payments run approximately .45 – 1.05% of the base loan amount.
MIP works similarly to borrower-paid mortgage insurance, but it has a few key differences.
Like BPMI, you’ll pay a monthly amount, typically rolled into your mortgage payment.
Here’s how it could work: You’ll pay an upfront payment that is 1.75% of the loan amount. If your home loan is for $200,000, expect to pay $3,500 at the time of closing.
Expect to pay an average of .85% of your home loan for MIP throughout the duration of your mortgage.
This percentage can run higher, depending on how much of a down payment you put down on your loan.