What is Mortgage Insurance?
Homebuyers across the country use mortgage insurance every day to realize their dream of becoming a homeowner.
Mortgage insurance (PMI) protects a lender’s investment (the mortgage loan) in case the homeowner fails to make payments. When buying a home with a down payment of less than 20% of the selling price, your mortgage payment will likely include PMI. Homeownership is more realistic for more people because of mortgage insurance.
What Does Mortgage Insurance Cover?
Millions of Americans rely on mortgage insurance as a useful tool to become homeowners. However, mortgage insurance is often seen as an avoid-at-all-costs obstacle to buying a home. Few terms used in the homebuying process are as misunderstood as mortgage insurance.
Without mortgage insurance, nearly everyone buying a home would need to save 20% of their home’s purchase price to buy it. Think about that. That’s $40,000 in your savings account to buy a modest $200,000 home. Many people still buy this way, but it would take most families years, if not decades, to save 20% for a downpayment. Enter: mortgage insurance.
Mortgage Insurance Definitions
You may be thinking, “I’ve never even heard of mortgage insurance”... you’re not alone. Mortgage insurance is more regularly referred to as PMI (private mortgage insurance) or MIP (mortgage insurance premium). There is a slight difference between the two, but for the purpose of this post we will use PMI as a placeholder for all mortgage insurance.
Private Mortgage Insurance (PMI)
The “private” in PMI refers to the insurance being issued by a private company – i.e. not the government. There are several companies that specialize in insuring mortgage loans for lenders, and most lenders use multiple insurance companies to insure their loans. If you are using a conventional mortgage loan to buy your house with less than 20% down, your mortgage insurance will come from a private company.
Mortgage Insurance Premium (MIP)
Government loans (FHA, VA, USDA) are insured – or “backed” – by the various agencies that oversee their origination. The premiums used to fund these programs are typically referred to as MIP, although each loan type has a more specific term we’ll address later. As far as the homebuyer is concerned, MIP is just a public (government) version of PMI.
Throughout your homebuying experience, MIP and PMI will be used interchangeably, so don’t get too caught up on the differences between the two. Just know that if you are not making at least a 20% down payment, you are probably paying one or the other in order to buy your home.
Types of Mortgage Loans & PMI
FHA loans are one of the easiest ways to buy a home without needing a 20% down payment. FHA loans only require 3.5% down. In allowing for a minimal down payment, FHA loans require MIP to be included in your house payment. FHA MIP is an annual insurance premium that is divided into 12 installments that are collected in your monthly payment.
In addition to the premium you pay monthly, FHA loans include an upfront mortgage insurance premium (FHA UFMIP). This premium is usually included in your loan amount. It is a fixed premium based on your base FHA loan amount. Calculating FHA MIP and the UFMIP is incredibly important when budgeting for your new home.
USDA Mortgage Insurance
Like FHA loans, USDA loans carry both an upfront premium – called a “guarantee fee” – and an annual mortgage insurance premium that is paid monthly as part of your house payment. USDA loans do not require a down payment, so if you meet their eligibility requirements, they are a great option. Additionally, the guarantee fee and annual premiums are currently lower than FHA’s UFMIP and MIP. Our USDA loan calculator will handle the calculations for any USDA loan amount.
VA Mortgage Insurance
If you are an eligible veteran or otherwise eligible for a VA loan, you’ll be thrilled to hear VA loans do not have any type of monthly or annual mortgage insurance. Instead, the VA collects a funding fee at closing, which is typically financed into your VA loan. The VA funding fee can even be waived in certain circumstances. Also, while VA loans do not require a down payment, the funding fee can be reduced by making a down payment. Use the VA loan calculator to determine how the funding fee applies given different down payment amounts.
Conventional Mortgage Insurance
A conforming or conventional mortgage is simply a loan that is not guaranteed or insured by the government agencies mentioned earlier. Traditionally, conventional loans would finance 80% of the purchase price of a home, while the homebuyer would account for the remaining 20% in the form of a down payment. Down payments of less than 20% became popular when private insurance companies began offering mortgage insurance to lessen the risk being taken by lenders willing to offer loans to people with smaller down payments.
Conventional PMI rates vary depending on several factors, including down payment amount, loan amount, credit score, and more. Your lender will provide options based on your specific scenario, which may include lender paid mortgage insurance.
How Much is Mortgage Insurance?
Using mortgage insurance to buy a home is unavoidable for many homebuyers. Obviously, most homebuyers would prefer not to incur the additional expense. However, that’s simply not realistic for the majority of families looking to purchase a home. Mortgage insurance provides an opportunity for homeownership that may otherwise take years (or more) to achieve and enjoy.
Find out how much PMI will ultimately cost you with our handy calculator.