What is Mortgage Insurance & When You Need It?

According to the latest census statistics, 64.8% of Americans own homes. Unfortunately, the 20% down payment mortgage requirement is unaffordable for many Americans.

This Urban Institute report shows that only 37% of millennials owned homes when they were 24-34 years old. 

Mortgage insurance gives lenders financial security to support homebuyers who don’t have the 20% down payment. When the down payment is low, the insurance premium is higher. Since the lender takes a risk by accepting a smaller downpayment, mortgage insurance protects lenders from losses. 

Mortgage insurance increases the cost of purchasing a home. However, it makes homeownership affordable because you can make a 3% down payment, pay the monthly insurance premium and start your homeownership journey. 

How Does Mortgage Insurance Work?

Mortgage insurance protects lenders in the same way that the 20% down payment did. However, it also makes it possible for more people to take mortgages.

So, both the lender and homebuyers benefit from mortgage insurance. Unfortunately, mortgage insurance increases the cost of the loan. 

How mortgage insurance works will depend on the type of loan. Conventional, Federal Housing Administration (FHA), USDA, and VA-backed mortgages are the loans supported by mortgage insurance.

Mortgage insurance is paid monthly and is canceled when the mortgage balance isn’t greater than 75-80%.  The terms of mortgage insurance vary depending on the type of loan you take.

When seeking mortgage insurance, you need to find out how the down payment affects the interest rates. You also need to know how conditions, such as your credit score, affect mortgage insurance.

This YouTube video is a guide to mortgage insurance and how it works:

Types of Loans & How They Affect Mortgage Insurance

Conventional Mortgage Loan

Private Mortgage Insurance (PMI) is usually attached to conventional mortgage loans. PMI is usually requested if the down payment is less than 20% of the property’s value.

PMI can be anywhere between 0.25% to 2%. Since the PMI rate depends on the mortgage amount, the more you borrow, the higher the rate. The PMI rate is adjusted annually, usually downwards, since the mortgage loan also falls. 

The PMI rate depends on the down payment, mortgage, loan term, and credit score. If the lender is taking a greater risk, the PMI rate will be higher.

PMI falls under four categories, these are:

Borrower-Paid Mortgage Insurance

Borrower-paid mortgage insurance (BPMI) is the most common PMI. Once your mortgage is approved, you’ll pat the agreed BPMI until you attain 22% equity of your home, based on the purchase price.

At this point, the lender won’t consider your loan a high risk, so mortgage insurance will be canceled automatically. It usually takes about 11 years of regularly making monthly BPMI payments to get to this point.

Some lenders approve cancellation applications when the equity is 20% of the property’s purchase price. Other lenders use home value appreciation as a benchmark when canceling BPMI.  

The other way to get rid of BPMI is by refinancing your mortgage. However, you should consider the cost of refinancing against the mortgage insurance premiums before deciding on the best option. 

Single-Premium Mortgage Insurance

If you opt for single-premium mortgage insurance (SPMI), you’ll pay mortgage insurance in a lump sum upfront or include it into the monthly mortgage payments. The advantage is your monthly mortgage payments are lower than that of BPMI. 

The downside of this option is you’ll lose the single premium payment you made should you refinance or sell the property. You’ll also keep paying interest on the insurance as long as you are paying the mortgage.

Lender Paid PMI

Lender-paid PMI (LPMI) is mortgage insurance where the lender pays the insurance and then raises the mortgage rate. 

LPMI may be advantageous if the mortgage repayment is lower than the other types of PMI. Unfortunately, the mortgage interest rate remains constant, even when you attain 22% equity.

Split Premium PMI

Split premium PMI allows you to pay a portion of the insurance as a lump sum at closing. The remaining amount is paid in monthly installments. The upfront payment helps to bring down the monthly payments.

Federal Housing Administration (FHA) Loan

The Federal Housing Administration (FHA) loans, like the PMI, are facilitated by private lenders. However, these loans are regulated and insured by the FHA, a government agency.  

If you’re eligible for an FHA mortgage, you can borrow up to 96.5% of the property’s purchase price. This means you only need to make a down payment of 3.5%. However, the downpayment will depend on your credit score. 

For example, to qualify for the lowest down payment, you need a credit score of at least 580. If your credit score is 500-579, you only qualify for the FHA loan if you make a 10% down payment. 

FHA loans require the buyer to pay FHA mortgage insurance. The premium remains the same irrespective of the credit score. However, if your down payment is below 5%, you’ll pay slightly more in mortgage insurance. 

The FHA mortgage loan has changed a lot over the years and will undoubtedly change should the need arise. Currently, if you make a down payment of less than 10% of the FHA loan, you’ll pay mortgage insurance until the loan term comes to an end. 

If you pay 10% of the purchase price, the mortgage insurance payments will cease after 11 years. The duration of the monthly mortgage payments will depend on the loan terms.

US Department of Agriculture Loan (USDA)

Although the USDA home loan is similar to the FHA loan, it’s cheaper. Part of the mortgage insurance is paid at closing and as monthly payments. If you can’t afford the upfront payment, you can roll the charge to monthly payments. 

People eligible for USDA loans don’t need to make a down payment. The interest rates are also quite low. Compared to conventional or FHA loans, USDA loans are more affordable.

VA-Backed Loans

VA-backed loans are available to service members, veterans, and their families. These loans don’t attract a monthly mortgage insurance premium. However, an upfront fee, known as a funding fee, is required.

The amount will vary, depending on the down payment, disability status, and type of military service. 

Do You Really Need Mortgage Insurance?

Mortgage insurance has helped millions of Americans to become homeowners. The low down payment and limited period of paying mortgage insurance make the extra cost worthwhile, especially when you consider how much you’d pay in rent during this period.