Mortgage insurance, also known as private mortgage insurance (PMI), is a type of insurance that protects lenders from the potential loss of a borrower defaulting on their mortgage. It is typically required for borrowers who make a down payment of less than 20% of the home’s purchase price. Borrowers are responsible for paying the mortgage insurance premium, which is usually added to their monthly mortgage payment.
How does mortgage insurance work?
When a borrower makes a down payment of less than 20% of the home’s purchase price, they are considered to be a higher risk to the lender. To mitigate this risk, the lender will require the borrower to purchase mortgage insurance. The premium for the insurance is typically added to the borrower’s monthly mortgage payment. If the borrower defaults on the mortgage, the insurance will pay the lender for any losses incurred as a result of the default.
What’s the cost of mortgage insurance?
The cost of mortgage insurance can vary depending on a number of factors. These factors include:
- Down payment: The smaller the down payment, the higher the risk to the lender, and therefore the higher the cost of mortgage insurance.
- Loan-to-value ratio: The loan-to-value ratio is the ratio of the loan amount to the value of the property. The higher the ratio, the higher the risk to the lender and the higher the cost of mortgage insurance.
- Credit score: A borrower’s credit score is an indicator of their creditworthiness and ability to repay the loan. Borrowers with lower credit scores are considered to be a higher risk to the lender, and therefore the cost of mortgage insurance for these borrowers will be higher.
- Loan type: Different types of loans have different mortgage insurance requirements and costs. For example, Federal Housing Administration (FHA) loans typically have higher mortgage insurance costs than conventional loans.
- Term of the loan: The term of the loan, or the length of time over which the loan is to be repaid, can also affect the cost of mortgage insurance. Shorter term loans typically have lower mortgage insurance costs than longer term loans.
On average, the cost of mortgage insurance is between 0.3% and 1.5% of the loan amount per year. However, the average cost of private mortgage insurance for a loan ranges from 0.58% to 1.86% of the original loan amount per year, according to the Urban Institute’s Housing Finance Policy Center.
How is mortgage insurance calculated?
The premium for mortgage insurance is typically calculated as a percentage of the loan amount. The percentage is determined by the loan-to-value ratio and the credit score of the borrower. The higher the loan-to-value ratio and the lower the credit score, the higher the premium will be.
Private Mortgage Insurance (PMI) vs. Mortgage Insurance Premiums (MIP)
Private Mortgage Insurance (PMI) and Mortgage Insurance Premiums (MIP) are both types of mortgage insurance, but they are designed for different types of loans.
Private Mortgage Insurance (PMI) is typically required for conventional loans with a loan-to-value ratio greater than 80%. The purpose of PMI is to protect the lender in the event of a borrower defaulting on their mortgage. The cost of PMI is usually a percentage of the loan amount, and it is typically paid monthly as part of the mortgage payment.
Mortgage Insurance Premiums (MIP) are required for Federal Housing Administration (FHA) loans. The purpose of MIP is similar to PMI, which is to protect the lender in the event of a borrower defaulting on their mortgage. MIP is typically higher than PMI and is paid in two parts: an upfront premium, which is typically financed into the loan, and an annual premium, which is paid monthly.
It’s important to note that some loans such as the USDA loans have their own mortgage insurance premium, called a “Guarantee fee” and VA loans have a “Funding Fee” which is a one-time, up-front fee paid at closing.
When comparing PMI and MIP, it’s important to consider the cost, the loan-to-value ratio and the loan type. PMI is usually less expensive, but it’s only available for conventional loans. On the other hand, MIP is typically more expensive but it is available for FHA loans which can be a good option for those with lower credit scores or limited funds for a down payment.
It’s also important to note that in some cases, PMI can be removed once the loan-to-value ratio reaches 80% while MIP is typically required for the life of the loan.
Types of Private Mortgage Insurance
There are four kinds of private mortgage insurance (PMI):
Borrower-Paid Mortgage Insurance
This type is paid by the borrower as a monthly premium, which is added to the mortgage payment. The cost of borrower-paid PMI is determined by the loan-to-value ratio, credit score of the borrower, and loan type. The premium is usually a percentage of the loan amount and it can vary based on the lender. Borrower-paid PMI can be canceled once the loan-to-value ratio reaches 80% but will automatically terminate at 78% .
Borrower-paid single premium
This is a one-time payment for the life of the loan, instead of a monthly premium. This option eliminates the need for monthly PMI payments but can increase the overall cost of the loan.
Lender-Paid
This type is paid by the lender as a one-time premium at closing. The cost of lender-paid PMI is typically higher than borrower-paid PMI. The loan-to-value ratio, credit score of the borrower, and loan type are taken into account when determining the premium. Lender-paid PMI cannot be canceled, and it is typically required for the life of the loan.
Split premium
This kind is a combination of borrower-paid PMI and lender-paid PMI. The borrower pays a portion of the premium as a monthly payment, and the lender pays the rest as a one-time premium at closing. This option can help to reduce the overall cost of the loan, but it may also increase the interest rate.
When is mortgage insurance required
Mortgage insurance is typically required when a borrower makes a down payment of less than 20% of the home’s purchase price. However, some types of loans such as FHA and USDA loans may require mortgage insurance regardless of the down payment amount.
How to get rid of mortgage insurance
There are a few ways to get rid of mortgage insurance. One way is to make additional payments towards the principal balance of the loan. As the loan-to-value ratio decreases, the lender may cancel the mortgage insurance. Another way is to refinance the loan into a conventional loan with a loan-to-value ratio of 80% or less. Additionally, if the borrower reaches 22% equity in their home, the lender is required to automatically cancel the mortgage insurance.
FAQ
How long do you pay for mortgage insurance?
The length of time you pay for mortgage insurance will depend on the type of loan and the loan-to-value ratio. For conventional loans, mortgage insurance is typically required until the loan-to-value ratio reaches 80%. For FHA loans, mortgage insurance is typically required for the life of the loan.
Do USDA loans require mortgage insurance?
Yes, USDA loans require mortgage insurance, known as a Guarantee Fee, which is similar to mortgage insurance on other loan types.
Do VA loans require mortgage insurance?
No, VA loans do not require mortgage insurance. Instead, they require a funding fee, which is a one-time fee paid at closing.
What’s the Difference Between Mortgage Insurance and Homeowners Insurance?
Mortgage insurance is a type of insurance that protects the lender in the event of a borrower defaulting on their mortgage. Homeowners insurance, on the other hand, is a type of insurance that protects the homeowner and their property from potential losses such as damage from natural disasters or theft.
Is Mortgage Insurance Tax Deductible?
The mortgage insurance premium was tax deductible in the past, but this provision expired at the end of 2018. You can no longer claim the deduction for 2022.
What happens if you don’t pay mortgage insurance?
If you don’t pay your mortgage insurance premium, the lender may cancel your insurance policy. This can be very dangerous for the borrower, as they will be responsible for the entire unpaid balance of the mortgage in the event of a default. Additionally, the lender may also foreclose on the property.
