What is mortgage insurance and how does it work?

Mortgage insurance, also called private mortgage insurance (PMI) or mortgage protection insurance (MPI) is an insurance policy that can be required by lenders for certain loans.

Mortgage insurance protects the lender against the risk of a borrower defaulting on a mortgage loan. When do you have to pay it and how does it work? Let’s dive in. 

What is Mortgage Insurance? What does it cover? 

Mortgage insurance is a policy that protects the lender should the borrower default on the loan for any reason. Because it provides the lender with protection, they’ll be more likely to provide a loan despite a smaller down payment. 

So if you put down less than 20% on your home purchase, the lender will require mortgage insurance. Or if you use an FHA loan, you’ll be required to pay for mortgage insurance. (FHA Loans are mortgages from private lenders that are insured by the government. Banks and other lenders are willing to work with “higher risk borrowers,” because they know that the Federal Government is backing the loan.)

Mortgage insurance is paid monthly and it rolls right into the monthly mortgage payment. The monthly cost of the insurance will vary depending on how much money the borrower does put down.

Mortgage insurance – though it can add costs in at the end – makes it easier for homeowners to purchase a home without having to put down more of a down payment than they can afford.  

How Mortgage Insurance Works 

The lender essentially requires mortgage insurance because the loan-to-value (LTV) ratio is greater than 80%. When the LTV ratio hits 80% or lower, the borrower can request to have the mortgage insurance removed if they have a conventional loan. This is not the case with an FHA Loan (which we’ll cover below). 

As the borrower, you can pay either a monthly payment or a lump sum at the closing that can go toward the monthly payments. This lump sum is a protective measure that lenders occasionally require. 

The Cost of Mortgage Insurance

The cost of mortgage insurance will depend on how much money the borrower puts down for a down payment at the closing. Other factors are considered as well such as the borrower’s credit score and whether the loan is a fixed rate or ARM.

Mortgage insurance can range from 0.5 – 1% of the loan amount per year. For example, if you take out a mortgage of $200,000, your PMI would be between $1000 to $2000. 

This is then broken down into monthly payments that get rolled in with your monthly mortgage payment. In this example you would be paying anywhere from $84 to $167 extra a month.

Mortgage Insurance for Different Loans

Let’s look at the different types of loans that are available and which ones will require mortgage insurance.

  • Conventional loans only require mortgage insurance if the borrower puts less than a 20% down payment. Once the LTV ratio hits 80% or lower the mortgage insurance can be dropped.
  • FHA Loans require mortgage insurance regardless of how much the borrower puts down. If the down payment is less than 10% the mortgage insurance premium (MIP) is there for the life of the loan or until you refinance. If the down payment is 10% or higher the MIP is there for 11 years.
  • VA Loans do not require mortgage insurance regardless of how much the borrower puts down.
  • USDA Loans do not require mortgage insurance regardless of how much the borrower puts down.

Mortgage Insurance Types

There are a few different types of mortgage insurance to be aware of. 

  • Private Mortgage Insurance (PMI): This is when a lender uses a private insurance company to protect the loan. The lender will secure the insurance plan and the borrower will pay for the coverage. The cost of the insurance will depend on how much money is put down at closing.
  • Mortgage Insurance Premium (MIP): For an FHA loan, there is a MIP required. The cost can vary depending on the down payment but regardless of how much is put down, the borrower will have to pay an MIP.
  • Mortgage Protection Life Insurance: Borrowers are offered a life insurance policy that protects their mortgage in the event of their passing prior to paying off the loan. This is always optional, but some lenders will require you to sign documents stating that you understand the risks involved and that you are choosing not to take out the insurance policy.

Mortgage insurance vs…

Let’s take a deeper look at these types of mortgage insurance and how they compare to each other.

Private Mortgage Insurance

Private mortgage insurance, or PMI, is just a longer term for mortgage insurance. They are one and the same. 

Qualified Mortgage Insurance Premium (MIP)

You will have MIP instead of PMI if you have an FHA Loan. MIP and PMI’s are similar, but for MIPs: 

  • If you put less than 10% down, you have to live out the MIP until the end of the loan. If you put 10% or more down, you’ll have to wait 11 years to cancel the MIP.
  • There is an upfront mortgage insurance premium (UFMIP) in addition to the annual MIP. This UFMIP is 1.75% of the loan amount and can either be paid as a lump sum at closing or financed and paid monthly.
  • MIPs are typically slightly less costly than PMIs.

Mortgage Title Insurance

There are two types of mortgage title insurance: lender title insurance and borrower title insurance. Most lenders require lender mortgage title insurance, which protects the lender in the case of unrecorded liens or unrecorded access rights. 

Borrower title insurance protects the borrower from lawsuits due to claims on the property. These claims can be against previous owners for not paying taxes or contractors that did work on the property. 

When the deed is transferred to the new owner, all claims on the property are now their responsibility.

Mortgage Protection Life Insurance

This life insurance policy specifically covers the cost of a mortgage should the borrower pass away prior to paying any amount of the loan off. This can be paid directly to the lender or to the heir of the borrower depending on how the policy was set up.

Homeowners Insurance

Homeowners insurance covers losses and damages to the property and the owner’s possessions. It also covers injuries that occur in the home or on the property. 

The cost of homeowners insurance depends on the liability limit and the deductible that is set by the homeowner. Most lenders will not issue the money for a loan on a house without first seeing proof of homeowners insurance. 

Mortgage Insurance FAQs

Is mortgage insurance required?

Yes, mortgage insurance is required for any when the loan-to-value ratio is greater than 80% or when the down payment is less than 20%. 

For an FHA loan, an MIP is required, but can end after 11 years if you put down more than 10%. 

What is the difference between PMI and MIP?

PMI is private mortgage insurance that is required by lenders offering conventional loans. MIP is a qualified mortgage insurance premium which is a government insurance policy required on FHA loans.

Mortgage isurance removal: How do I get rid of my mortgage insurance?

Conventional loans typically require a new appraisal and a written request to remove the PMI. Otherwise, the PMI will automatically be removed when the LTV ratio is below 78%.

As for a MIP on an FHA Loan, if your down payment was 10% or more it will automatically stop after 11 years.

Mortgage Insurance in Case of Death

You can take out a mortgage life insurance policy which will pay off the remaining loan amount in the case of death. You can opt for a policy that will cover only what is left of the loan, or one that pays out a set amount regardless of where the loan is at the time of death.

Mortgage Insurance Companies

There are many companies out there that offer mortgage life insurance policies and mortgage title insurance policies. But for PMI and MIP, the lender picks the insurance company and provides the policy. 

Bottom Line: Do You Need Mortgage Insurance?

If you have a down payment of less than 20% on a conventional loan or you decide to take out an FHA loan, then you’ll be required to pay mortgage insurance. Otherwise, no, mortgage insurance is not required! 

Whether you decide to keep your mortgage covered with an insurance policy or not, The Home Loan Expert can help you throughout the home loan process. 

We’re always happy to sit down with our clients and offer them personalized support to make their homeownership dreams come true. 

Contact us today for a consultation or get started with our 5-minute loan approval application today. 

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