Mortgage Insurance: What It Is And When It’s Required
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Mortgage insurance can help homebuyers get an affordable, competitive interest rate and more easily qualify for a loan with a down payment as low as 3%. In exchange for these better terms, the borrower pays insurance premiums each month—usually for at least several years.
What Is Mortgage Insurance?
Mortgage insurance is a type of policy that protects a mortgage lender if a borrower fails to make their payments. While mortgage insurance is designed to protect the lender, this reduced risk allows lenders to offer loans to borrowers who otherwise wouldn’t qualify for a mortgage at all, let alone an affordable one.
Lenders traditionally require a down payment of 20% as a condition of qualifying for a mortgage since a borrower who invests their own money in their home is less likely to give up on making payments and let the bank foreclose on the home if their home’s value drops or their personal finances deteriorate. Both of these scenarios were seen during the 2007 housing crisis and recession, which highlighted the importance of mortgage insurance.
Note that conventional loan borrowers with lower down payments pay private mortgage insurance (PMI) while borrowers who get a loan backed by the Federal Housing Administration (FHA) pay a mortgage insurance premium (MIP).
Types of Mortgage Insurance
There are four kinds of PMI:
- Borrower-paid monthly. This is just what it sounds like—the borrower pays the insurance monthly typically as part of their mortgage payment. This is the most common type.
- Borrower-paid single premium. You’ll make one PMI payment up front or roll it into the mortgage.
- Split premium. The borrower pays part up front and part monthly.
- Lender paid. The borrower pays indirectly through a higher interest rate or higher mortgage origination fee.
You might choose one type of PMI over another if it would help you qualify for a larger mortgage or enjoy a lower monthly payment.
There’s only one type of MIP, and the borrower always pays the premiums. But FHA loans don’t just have monthly MIPs. They also have an up-front mortgage insurance premium of 1.75% of the base loan amount. In this way, the insurance on an FHA loan resembles split-premium PMI on a conventional loan.
How Much Is Mortgage Insurance?
Mortgage insurance is calculated as a percentage of your home loan. The lower your credit score and the smaller your down payment, the higher the lender’s risk, and the more expensive your insurance premiums will be. But as your principal balance falls, your mortgage insurance costs will go down, too.
For borrower-paid monthly private mortgage insurance, annual premiums from MGIC, one of the country’s largest mortgage insurance providers, range from 0.17% to 1.86% of the loan amount, or $170 to $1,860 for every $100,000 borrowed, on a fixed-rate 30-year loan. That’s $35 to $372 per month on a $250,000 loan.
Some PMI policies, called “declining renewal,” allow your premiums to decrease each year when your equity increases enough to put you in a lower rate bracket. Other PMI policies, called “constant renewal,” are based on your original loan amount and don’t change for the first 10 years.
On an adjustable-rate loan, your PMI payment can go as high as 2.33%. That’s $2,330 for every $100,000 borrowed, or $485 a month on a $250,000 loan. PMI also is more expensive if you’re getting a mortgage on a second home.
The most likely scenario with an FHA loan is that you’ll put down less than 5% on a 30-year loan of less than $625,500 and your MIP rate will be 0.85% of the loan amount per year. MIPs on a 30-year loan range from 0.80% to 1.05% annually, or $800 to $1,050 for every $100,000 borrowed. That’s $167 to $219 per month on a $250,000 loan.
The lowest rates go to borrowers with larger down payments, and the highest rates go to people borrowing more than $625,500. Your credit score is not a factor in MIPs.
How Long Do You Have to Pay for Mortgage Insurance?
With PMI, the borrower pays monthly insurance premiums until they have at least 20% equity in their home. If they fall into foreclosure before that, the insurance company covers part of the lender’s loss.
With MIPs, you’ll pay for as long as you have the loan unless you put down more than 10%. In that case, you’ll pay premiums for 11 years.
Private Mortgage Insurance vs. Mortgage Insurance Premiums
While PMI applies to conventional mortgages with less-than-standard down payments, you’ll likely need to pay MIP if you get an FHA loan. Here’s how they work:
Private Mortgage Insurance
This is typically required for conventional mortgage borrowers who put 3% to 19.99% down. Borrowers who pay PMI are more likely to be first-time homebuyers and are usually purchasing, not refinancing. They also tend to have slightly higher debt-to-income (DTI) ratios and lower credit scores than conventional borrowers who don’t pay PMI, according to the Urban Institute.
Mortgage Insurance Premiums
This is required for borrowers who get a loan backed by the FHA. The main reason to pay an MIP is that doing so might be the only way you can qualify for a home loan. The Urban Institute finds that FHA borrowers tend to have lower credit scores and more debt relative to their income than conventional borrowers who pay PMI.
The percentages fluctuate from year to year, but overall, about 30% of borrowers who carry a loan with a guarantee or mortgage insurance pay MIP. Another 42% pay PMI, and the remaining 30% take advantage of the loan program offered by the Department of Veterans Affairs (VA), which includes a lender guarantee but doesn’t require PMI or MIPs.
If you take out a loan backed by the U.S. Department of Agriculture (USDA), you’ll have to pay an upfront loan guarantee fee of 1% and an annual mortgage insurance fee of 0.35% of the loan amount, paid monthly.
How to Get Rid of Mortgage Insurance
The process for getting rid of mortgage insurance depends on which type you have.
For a conventional mortgage with borrower-paid monthly premiums, you can get rid of PMI after you accumulate 20% equity by paying down your mortgage. You can also get rid of PMI if:
- Your home’s value goes up enough to give you 25% equity, and you’ve paid PMI for at least two years
- Your home’s value goes up enough to give you 20% equity, and you’ve already paid premiums for five years
- You put extra payments toward your loan principal to reach 20% equity faster than you would have through regular monthly payments
You’ll need to ask your lender in writing to waive PMI if one of these things happens. For cancellation based on an increase in home value, your lender may require an appraisal. You’ll also need to be current on your payments and have a good payment history for the lender to grant cancelation at this point.
The passive way to get rid of insurance is to make mortgage payments every month until you have 22% equity. Federal law requires your lender to cancel PMI automatically at this point as long as you’re current on payments.
Another way you might get rid of PMI is through refinancing to get a lower rate or shorter term. You won’t need PMI on the new loan if your home’s value has gone up enough or you do a cash-in refi, which means making a lump-sum payment at closing to lower your mortgage balance.
How to Avoid Mortgage Insurance
If you’re getting an FHA loan, you can’t avoid mortgage insurance. If you’re getting a conventional loan, you’ll typically need to put down 20% to avoid insurance. You also have the option to save up a larger down payment and buy later, or buy a less expensive home.
An alternative to paying PMI on a conventional loan is to take out two mortgages instead of one. The first will cover 80% of the purchase price. The second will cover 10% to 17% of the purchase price and will have a higher interest rate. You’ll make a down payment of 3% to 10% to cover the rest of the purchase price.
These loans are sometimes called 80/10/10 loans or piggyback loans. Don’t assume that it will be less expensive to go this route; you’ll need to compare actual mortgage quotes to find out.
You may find special programs through your state or city for first-time homebuyers that can help you avoid PMI. Through certain lenders, you may also find low down payment mortgages that don’t require PMI.
For example, you may be able to put down just 3% without paying PMI if you have a modest income or are a first-time homebuyer, thanks to down payment and closing cost assistance. In exchange, you may have to complete a homebuyer education program.
If you’re a qualifying military service member, surviving spouse or member of the National Guard or reserves, you may qualify for a VA loan, which doesn’t charge insurance despite allowing a down payment as low as 0%.
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Bottom Line
For both personal and financial reasons, you might decide that buying a home sooner is worth it even if it means paying PMI or MIPs. Millions of borrowers clearly think mortgage insurance is worth paying for, or they’d keep renting until they qualified for a loan that didn’t require it. At the same time, insurance does increase the monthly cost of home ownership for many borrowers, and wanting to avoid or minimize that cost is also a logical choice.
Frequently Asked Questions (FAQs)
How Is Mortgage Insurance Calculated?
Mortgage insurance is based on your loan amount. To estimate how much you’ll pay for mortgage insurance, you’ll first need to calculate your loan-to-value (LTV) ratio. To do this, divide your loan amount by your property value. You’ll then multiply this by your PMI percentage, which your lender can provide.
PMI percentages can range from 0.22% on the low end up to 2.25% on the high end—you can use these percentages if you don’t have your PMI percentage from your lender.
What’s the Difference Between Mortgage Insurance and Homeowners Insurance?
You might have to pay both mortgage insurance and homeowners insurance—but while they might sound similar, they’re actually quite different.
- Mortgage insurance: protects the lender if a borrower defaults on their loan.
- Homeowners insurance: protects the homeowner in case of damage to your house or belongings.
Is Mortgage Insurance Tax Deductible?
While homeowners were previously allowed to deduct mortgage insurance premiums from their taxes in some cases, this deduction expired following the 2021 tax year.
Do You Have to Have Mortgage Insurance?
If you’re getting a conventional mortgage and your down payment is less than 20%, you’ll likely have to pay for PMI. But if you’re able to put at least 20% down, you can avoid mortgage insurance.
For FHA loans, mortgage insurance is unavoidable.