Mortgage Insurance: Types, Costs, and When It’s Required

In the world of personal finance, mortgages are a hot topic of discussion. No matter your income, mortgage payments are a huge time, financial, and patience commitment. However, they also lead to one of the most rewarding aspects of personal finance: homeownership. Traditionally, a mortgage requires a 20% down payment on the home's purchase price.…

Written by

Tyler Arnaiz

Published on

June 21, 2024

In the world of personal finance, mortgages are a hot topic of discussion. No matter your income, mortgage payments are a huge time, financial, and patience commitment. However, they also lead to one of the most rewarding aspects of personal finance: homeownership.

Traditionally, a mortgage requires a 20% down payment on the home’s purchase price. However, not everyone can afford a significant 20% down payment. Thankfully, you can still buy a home with less money down, as different types of mortgages are available for all incomes and situations.

There’s just one caveat to a mortgage with less than 20% down, and it’s called mortgage insurance. The homeowner pays Mortgage insurance to replace a 20% down payment, typically as an additional monthly cost (though not always). Since homeowners are paying a down payment of less than 20%, there is risk involved in lending to them. Mortgage insurance protects the lender by lowering that risk.

Arnaiz Mortgage is a mortgage broker with extensive experience with lenders that require mortgage insurance of many different kinds. Insurance is typical with loans such as Federal Housing Administration (FHA) loans, which traditionally feature a less than 20% down payment. We can answer any specific questions not answered in this article at any time. Contact us today; we’re ready and waiting to help answer questions and ease your concerns.

What Does Mortgage Insurance Cover, and Why Do Lenders Require It?

Mortgage insurance protects a mortgage lender if a mortgage isn’t paid off properly. When a mortgage down payment is less than 20%, there’s a more significant risk a borrower defaults on their loan. Mortgage insurance lowers this risk and guarantees the lender will receive their money back in some form or another through the insurance policy. This is standard for all mortgages with lower down payments; it’s not on a case-by-case basis.

As mentioned, lenders typically require mortgage insurance when a more significant amount of risk is involved with lending to you. This usually occurs when you pay less than 20% of a down payment on your loan or if you have a specific type of loan where it is required, such as FHA loans or United States Department of Agriculture (USDA) loans.

This is different from homeowners insurance, which protects the borrower. Insurance for a mortgage protects the lender in case payments fall behind or aren’t made for any reason, such as income loss, death, or others.

When a homeowner puts 20% down on a house, they have 20% equity. When a homeowner has no equity in their home, they’re more likely to fall behind or default on their loan due to higher monthly payments, lower investment in the property, and more. This is why lenders require it on lower down payments.

Who Pays for Mortgage Insurance?

Despite mortgage insurance benefitting the lender, depending on the type, a few parties are responsible for paying the insurance.

  • The Borrower: Typically, those borrowing the money will pay the insurance. They either pay mortgage insurance premiums in a lump sum upfront or they have a smaller monthly insurance payment along with their loan payment.
  • The Lender: Technically, the lender won’t pay the mortgage insurance themselves, but they will work it into the mortgage on the borrower’s behalf through a higher interest rate on the mortgage or a higher origination fee. This is known as lender-paid mortgage insurance despite the borrower technically paying these fees. It’s an alternative way to finance the insurance directly into the loan without worrying about separate payments.

How Mortgage Insurance Impacts Your Monthly Payment

You can pay mortgage insurance (MI) by lumping it into your monthly mortgage payment in addition to homeowners insurance, loan principal, and interest. In a conventional loan, you typically only pay the loan principal, interest, and homeowners insurance. Your mortgage insurance premium is an additional cost. It raises your monthly payment, but it usually means you’ve paid a lot less upfront than a 20% down payment.

If you go the lender-paid route, you won’t have a separate insurance payment for the mortgage (outside of homeowners insurance). Still, you will have a higher monthly payment due to higher interest rates since the insurance raises the mortgage interest rate.

If you pay a single premium for your insurance, you won’t likely have to worry about your monthly mortgage payment being higher because you’ve already paid your premium upfront. 

Types of Mortgage Insurance

While MI of all types has the same purpose, there are different ways in which it is paid and issued to the borrower. It can be an additional monthly payment known as borrower-paid, worked into the loan itself with lender-paid, or paid entirely upfront with single-premium.  

Borrower-Paid Mortgage Insurance

Borrower-paid mortgage insurance is the most common type of payment method for mortgage insurance. The insurance premiums are added to the monthly mortgage payment, raising your monthly mortgage payments, but the overall cost of the loan is lower. Mortgage insurance typically can be canceled after around 20% of equity is in the home (similar to putting down a 20% down payment).

Lender-Paid Mortgage Insurance

As previously explained, this type of mortgage insurance is worked into the overall cost of your mortgage. This is either through a higher interest rate or additional origination fees. That way, you’re not paying a separate mortgage insurance payment, but the ‘lender’ is giving you a more expensive loan to make up for it. This is ideal for those planning to refinance their home loan in a few years, especially when the borrower has more equity in the home.

FHA Mortgage Insurance Premium (MIP)

An FHA loan is a particular type of loan that requires mortgage insurance. Unlike a conventional loan, FHA mortgage insurance is always required, and the amount paid is typically a certain percentage of the overall home’s price (similar to a down payment). The Federal Housing Administration issues these loans to make homeownership more accessible, and FHA mortgage insurance is the price paid to obtain such a loan. These insurance premiums are canceled only after certain conditions have been met.

Single-Premium Mortgage Insurance

The single-premium mortgage insurance means paying your insurance upfront in one payment (premium). That way, there is no additional monthly payment on top of your mortgage, just a single lump sum upfront. This benefits those who would rather have lower monthly payments and one single cost upfront. It’s also known as an upfront mortgage insurance premium. However, this may not be suitable for those who do not have the income to provide a lump sum.

Split-Premium Mortgage Insurance

As the name implies, a split-premium mortgage insurance payment is split between an additional monthly payment amount and an upfront premium. This lowers the cost of what is due both upfront and monthly by paying a split between the two.

How Much Does Mortgage Insurance Cost?

A mortgage insurance premium costs a variable amount depending on a few factors. The cost will increase or decrease depending on credit score or how much the loan or home costs. If you’re buying a second home, it can raise mortgage insurance costs, as that’s typically a higher-risk purchase.

Factors That Affect Your Mortgage Insurance Rate

Many factors determine specific private mortgage insurance rates. Credit score, loan-to-value ratio, and the type of loan are some of the most important factors. Still, minor factors include the loan amortization terms, how long you’ve been paying, and even how you occupy the home.

Loan-to-Value Ratio (LTV)

The loan-to-value ratio compares how much your loan costs with how much your home is appraised to be worth. If your property value is lower, meaning you have a high loan-to-value ratio, there is a higher risk for the lender. This increases your insurance rates.

On the other hand, if you have a low loan-to-value ratio, it can improve mortgage insurance rates. This means that you’re borrowing less with a higher property value. This ratio is a significant deciding factor for insurance rates. 

Credit Score

Credit score determines how risky you are as a borrower. If you have a lower credit score, this may indicate that you’ve struggled with paying other commitments. Therefore, your mortgage insurance premium will likely be higher than better credit scores. The threshold for high vs low credit scores is typically around 680. You can even be denied PMI if your credit score is low enough.

Loan Type

What type of loan you have can impact your mortgage insurance rate. Fixed-rate mortgages tend to have lower mortgage insurance rates than variable-rate mortgages, as fixed payments are generally seen as less risky.

Additionally, a conventional mortgage will likely have a higher mortgage insurance rate than an FHA loan. This is because FHA loans tend to target lower or moderate incomes; conventional ones do not.

Average Mortgage Insurance Costs

As a general rule of thumb, one can expect to pay around 0.5-1.5% of the loan amount in private mortgage insurance premiums, though costs can fluctuate outside this range. Lower credit scores or higher-risk loans can raise the rate as high as nearly 2% of the purchase price. Speaking with a lender or mortgage broker can help you calculate a more accurate insurance cost for your situation.

Calculating Mortgage Insurance Premiums

Calculating your mortgage insurance can be tricky without knowing your purchase price. However, you can use your pre-approval amount to calculate an estimate or estimate how much you can afford. There are many online mortgage insurance calculators to help with this, but you’ll want to multiply your loan amount by the PMI rate and then divide that by twelve. 

For example, a $300,000 pre-approval amount or purchase price of a home with a $35,000 down payment is only 10% of the purchase price. Therefore, PMI will be required on a conventional loan. With an interest rate of 6% and a credit score of 620-639 on a 30-year loan, the estimated PMI will be 1.5% of the purchase price. This monthly payment is around $400 and around $35,000 for almost 7.5 years until 20% equity is reached.

When is Mortgage Insurance Required and When Not?

Mortgage insurance is only required for specific lenders, down payments, and loan types. Conventional mortgages with typical down payments of 20% or more typically do not require mortgage insurance.

Down Payment Size and Mortgage Insurance

If your down payment is less than 20%, you can typically expect to pay mortgage insurance until your home equity reaches 20%. Any loan or lender that allows you to pay less than 20% down will require mortgage insurance unless stated otherwise, but this is rare.

Loan Type and Mortgage Insurance Requirements

Certain loan types will typically require mortgage insurance, such as an FHA loan, due to their down payment requirements. 

  • FHA Loan: These will almost always feature a down payment amount of less than 20% and lower closing costs. This allows low-to-moderate-income individuals to purchase a home more easily. However, it comes at the expense of paying insurance on the loan.
  • Conventional mortgage loans do not always require paying PMI, but it is required if your down payment is less than 20%.
  • USDA Loan: This type of loan is issued when a borrower purchases a home in designated rural areas with lower down payment requirements. As down payments are lower, they typically require insurance.

Exemptions from Mortgage Insurance

You can avoid mortgage insurance by placing 20% down on your home when purchasing it, regardless of loan type. Veterans Affairs (VA) loans typically do not require PMI, and certain first-time homeowner programs offer reduced or no PMI payment.

Can Private Mortgage Insurance Be Cancelled?

Your PMI payment can be canceled under certain circumstances. You have to have a certain amount of equity or on-time payments, depending on your loan type. In many circumstances, you will not have to pay PMI forever.

Canceling Private Mortgage Insurance (PMI) on Conventional Loans

For conventional mortgages, you can cancel PMI when your mortgage balance reaches 78% of the home’s value. This ensures you’ve paid your loan enough to have around 20% equity.

Removing Mortgage Insurance Premiums from FHA Loans

On FHA loans, canceling mortgage insurance is done differently than a conventional mortgage loan. You must have at least 11 years of on-time payments on your mortgage, assuming you have put at least 10% down on your home already.

Refinancing to Get Rid of Mortgage Insurance

You can also cancel PMI through refinancing. Once you can refinance to ensure your mortgage balance is less than 80% of your home’s value, you are effectively removing mortgage insurance through refinancing.

Summary

PMI protects the loan servicer when lending to higher-risk borrowers. Mortgage lenders of all types will require PMI or other mortgage insurance if you put less than 20% for a down payment. This excludes VA loans, but USDA loans and FHA loans require insurance. Even a conventional loan will require it if paying less than 20% down.

It can be paid monthly with your mortgage payments, upfront, or split between the two. There is also a lender-paid PMI option, in which your lender will work your insurance costs into the loan’s interest rate and/or origination fees.

A PMI expense does not have to last forever. They can be canceled or refinanced once a certain percentage of your loan is paid off or if your home equity reaches a certain amount; this amount depends on the loan.

How much insurance you will pay depends on several factors, including home equity, a low credit score, loan value ratio, and other factors. Your lender or mortgage broker can help you with specific costs and types of insurance depending on your situation and loan type.

Arnaiz Mortgage specializes in connecting you with the right lender and loan for your situation. If you need to make any type of mortgage insurance payment, we will be with you every step of the way to answer any questions you may have and work with your lender to find the right solution for you.
You can contact Arnaiz Mortgage any time through multiple channels, whichever is more convenient. We can be reached at (623) 806-4645, or you can request an online quote.

Frequently Asked Questions

Is Mortgage Insurance Permanent?

No, you will not be paying it forever. It can be canceled or even refinanced once your home equity or mortgage balance drops or reaches a certain threshold. It differs depending on the loan and types of mortgage insurance.

Is Mortgage Interest Insurance or PMI Tax Deductible?

Yes, but it depends on several factors. PMI is tax deductible depending on the year you are filing taxes. Certain income thresholds and tax situations also allow tax deductions on your mortgage insurance. It’s important to consult with the IRS or your tax preparer for more information on your specific situation.

Can You Finance PMI?

Yes. Lender-paid PMI lets you finance your insurance by working it into the mortgage’s interest rate, origination fees, or both. That way, you don’t have a substantial set expense for it in your monthly payments.