Mortgage Insurance – How it Works and When You Need It

Mortgage insurance has two main benefits. It can help you qualify for a home loan you might not otherwise be able to get and helps protect or lower the risk to the lender for making a loan to you. Mortgage insurance is required if you get an FHA mortgage or put down less than 20% on a conventional loan.

How does mortgage insurance work?

The homebuyer pays for the insurance coverage, which compensates the lender if they default on the mortgage. The cost and other details can vary by the type of loan.

Mortgage insurance pays the lender a portion of the principal if a mortgage holder stops making mortgage payments. However, the homeowner is still responsible for the loan, and the home could be lost in foreclosure if you fall too far behind on payments.

This coverage differs from mortgage life insurance, which pays off the remaining mortgage if the borrower dies, or mortgage disability insurance, which pays the mortgage for a certain period if the borrower becomes disabled.

PMI for conventional mortgages

Private Mortgage Insurance (PMI) is a type of mortgage insurance buyers are typically required to pay with a conventional loan when they make a down payment less than 20% of the home’s purchase price. It is designed to protect the lender.

Many lenders offer low down payment programs, allowing a buyer to put down a smaller amount such as 3%. In return, the mortgage holder is required to buy PMI, which protects the lender’s investment in case a buyer fails to repay the mortgage.

The reason lenders require PMI coverage for down payments below 20% of the purchase price is because a buyer owns a smaller stake in their home. Mortgage lenders are lending more money up front and, so they stand to lose more if a consumer defaults in the initial years of ownership.

The estimated cost of PMI will vary according to the size of your home loan, your credit score, and other factors. Typically, the monthly PMI premium is included in your mortgage payment. You can ask to cancel PMI after you have over 20% equity in your home.

Federal Housing Administration (FHA) Mortgage Insurance

FHA loans feature minimum down payments as low as 3.5% and have easier credit qualifications than conventional loans. However, most FHA home loans require an upfront mortgage insurance premium (MIP) and an annual premium regardless of the down payment amount.

The upfront premium is 1.75% of the loan amount and is due when the mortgage closes. You can pay in cash or roll the amount into the loan. The annual MIP is paid in monthly installments for the life of the FHA loan if you put down less than 10%. If you put down more than 10%, you pay MIP for 11 years. The annual premium ranges from 0.15% to 0.75% of the average outstanding loan balance. The fee varies depending on your down payment, loan amount and loan term. Most home buyers will pay 0.55%, according to the FHA.

Fees for USDA and VA Loans

USDA loans, guaranteed by the U.S. Department of Agriculture, and VA loans, backed by the U.S. Department of Veterans Affairs, do not require mortgage insurance. However, they do include borrower-paid fees to protect lenders.

USDA Guaranteed Fee

USDA loans are zero-down-payment loans for rural home buyers. USDA loans issued by lenders have two fees: an upfront guaranteed fee paid when the mortgage closes and an annual fee paid every year for the life of the loan. The upfront guaranteed fee is 1% of the loan amount. The annual fee is 0.35% of the average outstanding loan balance for the year, which is divided into monthly installments and included in your mortgage payment. The federal government evaluates the fees each fiscal year and can change them. But a mortgage holders fee amount will not fluctuate; it is fixed when the loan closes.

VA Funding Fee

VA mortgages require no down payment and feature low interest rates for active, disabled, or retired military service members, certain National Guard members and reservists, and eligible surviving spouses. These loans don’t require mortgage insurance, but most borrowers will pay a funding fee currently ranging from 1.25% to 3.3% of the loan amount for purchase loans. The fee varies based on your down payment amount and whether this is your first VA loan.

If you have questions about mortgage insurance and home financing in general, reach out and contact Town & Country’s Mortgage Team here.

Prepared by Shannon Segars, Mortgage Loan Officer (NMLS ID: 1414185) for Town & Country FCU.