If you're planning to buy a home, you may have heard that putting less than 20% down means you'll have to pay mortgage insurance. But what exactly is mortgage insurance, why is it required, and how does it affect your monthly payment?
Mortgage insurance helps make homeownership possible for buyers who don't have a large down payment saved. While it adds to the cost of your loan, it can also allow you to purchase a home sooner rather than waiting until you've saved 20%.
Here's what you should know about the different types of mortgage insurance and how they work.
What Is Mortgage Insurance?
Mortgage insurance is designed to protect the lender if a borrower stops making mortgage payments and the lender experiences a loss.
It does not protect you from missing payments, losing your job, or facing foreclosure. That's an important distinction between mortgage insurance and other products, such as mortgage protection or life insurance.
Although mortgage insurance protects the lender, it can benefit homebuyers by making it possible to qualify for a mortgage with a smaller down payment.
When Is Mortgage Insurance Required?
Whether you'll need mortgage insurance depends largely on the type of home loan you choose and how much you're putting down.
Here are some of the most common loan types and how their insurance requirements work.
Conventional Loans: Private Mortgage Insurance (PMI)
If you're getting a conventional mortgage and putting down less than 20% of the home's purchase price, you'll typically need private mortgage insurance, also known as PMI.
PMI is provided by private insurance companies and arranged through your lender. It can be paid in several ways:
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Monthly: Added to your regular mortgage payment.
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Upfront: Paid as a one-time premium at closing.
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Combination: A portion is paid upfront, with the remainder paid monthly.
The available options and costs depend on the loan and lender.
FHA Loans: Mortgage Insurance Premium (MIP)
FHA loans require mortgage insurance regardless of the down payment amount.
FHA mortgage insurance includes two parts:
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Upfront mortgage insurance premium: Generally paid at closing, although it can typically be added to the loan balance.
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Annual mortgage insurance premium: Usually paid in monthly installments as part of your mortgage payment.
How long you'll pay the monthly premium depends on factors such as your original down payment and loan term. For many borrowers putting less than 10% down, the monthly premium lasts for the life of the loan.
USDA Loans: Guarantee Fees
USDA loans also include fees that help protect the loan program. These generally consist of an upfront guarantee fee and an annual fee, which is typically collected through monthly mortgage payments.
These fees help make USDA financing available to eligible borrowers purchasing homes in qualifying rural and suburban areas.
VA Loans: Funding Fee
VA loans are different from the other programs listed above. They do not require monthly mortgage insurance.
However, most borrowers pay a one-time VA funding fee. The amount varies based on factors such as military service, down payment, loan type, and whether you've used your VA loan benefit before. Some borrowers are exempt.
How Much Does Mortgage Insurance Cost?
The cost of mortgage insurance varies depending on the loan program and your individual circumstances.
For conventional loans, PMI costs can depend on factors such as:
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Your down payment amount
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Your credit score
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Your loan amount
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Your loan term and other loan characteristics
Generally, a smaller down payment can mean a higher PMI cost because the lender is taking on more risk.
FHA and USDA insurance costs are calculated differently and follow program-specific requirements.
When comparing mortgage options, don't look at the interest rate alone. Be sure to consider mortgage insurance, upfront fees, closing costs, and your total monthly payment.
Can You Remove Mortgage Insurance?
In some cases, yes! How and when you can stop paying depends on the type of mortgage you have.
Removing PMI on a Conventional Loan
One advantage of conventional PMI is that it can generally be canceled once you build enough equity in your home.
Under the Homeowners Protection Act, you can typically request PMI cancellation when your mortgage balance reaches 80% of the home's original value, provided you meet certain requirements. These may include having a good payment history, being current on your mortgage, and meeting the servicer's requirements.
If you don't request cancellation, PMI generally terminates automatically when your balance is scheduled to reach 78% of the home's original value, as long as you're current on your payments.
Your loan servicer can explain your specific cancellation timeline and requirements.
Removing FHA Mortgage Insurance
FHA mortgage insurance follows different rules than conventional PMI. For many newer FHA loans, monthly mortgage insurance remains for the life of the loan.
Depending on your original down payment and loan terms, you may have a shorter mortgage insurance period. Refinancing into a different loan may be an option for some homeowners, but it's important to compare the costs and benefits before making that decision.
What About USDA and VA Loans?
USDA guarantee fees and VA funding fees follow their own program rules. They aren't subject to the same PMI cancellation requirements as conventional loans.
If you're unsure about the fees associated with your loan, your loan servicer or loan officer can help explain what applies.
Is Mortgage Insurance Worth It?
Mortgage insurance may add to your monthly housing costs, but it doesn't automatically mean you should wait until you have 20% saved before buying a home.
For some buyers, purchasing with a smaller down payment may make more sense than waiting several years to save more. Others may prefer to put more money down to reduce their loan balance and avoid PMI.
The right choice depends on your savings, budget, financial goals, and available loan options.
A loan officer can help you compare different scenarios so you can understand how your down payment, interest rate, mortgage insurance, and overall payment fit together.
Have Questions About Mortgage Insurance?
You don't have to put 20% down to become a homeowner. Understanding your loan options can help you make a more informed decision about what works for your budget.
Whether you're just starting to explore homeownership or are ready to move forward, an Embrace Home Loans loan officer can help you understand your options and find a mortgage that fits your needs.
Mortgage insurance requirements, fees, and cancellation rules vary by loan program and borrower circumstances. Loan approval and terms are subject to applicable program guidelines and lender requirements.
