What You Need to Know About Mortgage Insurance
Low down payment mortgages make it possible for about four out of every five first-time buyers to become homeowners without struggling for years to scrape together a 20 percent down payment. The median down payment made by first-time buyers today is only five percent.
The price that buyers pay for lower down payments is mortgage insurance. Lenders require buyers who put down less than 20 percent of the purchase price to take out insurance. Even though homeowners pay for the insurance, it benefits only their lenders.
Buyers don’t like mortgage insurance, and they try to avoid it if they can. Annual premiums can cost from 0.3 to 1.5 percent of the loan amount. The cost depends upon several factors, including the quality of the borrower’s credit, the size of the down payment, and the type of mortgage. The better your credit score and the larger your down payment, the better a rate you’ll get.
For many first-time buyers, mortgage insurance is an unpleasant surprise that they discover only after they begin to apply for a mortgage with a low down payment loan. Many decide to delay their home buying plans until they can afford to put 20 percent down. Saving for a down payment may take anywhere between three and 13 years, depending on local home prices and a buyer’s ability to save.
Even at the very lowest rates, mortgage insurance adds hundreds of dollars to the annual cost of owning a home. On a $200,000 home, a homeowner puts down 10 percent, and the annual cost of mortgage insurance is 0.3 percent of the loan principal, they will pay $47.50 a month, or $570 a year.
To encourage home buyers following the housing crash a decade ago, Congress passed temporary legislation to make mortgage insurance payment tax deductible. That legislation expired at the end of 2017 and mortgage insurance premiums can no longer be deducted.
Types of Mortgage Insurance
There are four varieties of mortgage insurance private or “PMI”, FHA, VA, and USDA. Private mortgage insurance is provided by insurers who work with mortgage lenders. The three government agencies guarantee low down payment loans are the Federal Housing Administration, the Department of Veterans Affairs and the Rural Development Administration of the US Department of Agriculture. Borrowers who take out mortgages from one of the three government agencies are also required to take out their mortgage insurance.
Private mortgage insurance (PMI) protects private lenders who originate conventional low down payment mortgages. Rates are generally cheaper than FHA rates for borrowers with good credit. Most private mortgage insurance is paid monthly, with little or no initial payment required at closing.
The Federal Housing Administration operates its mortgage insurance, called Mortgage Insurance Premium (MIP). FHA mortgage insurance is required for all FHA loans. It costs the same no matter your credit score, with only a slight increase in price for down payments less than five percent. FHA mortgage insurance includes both an upfront cost, paid as part of your closing costs, and a monthly cost, included in your monthly payment.
The annual MIP for most new FHA loans ranges from 0.45 percent to 1.05 percent of the loan amount. The exact cost within that range depends on the loan size, loan term, and loan-to-value (LTV) ratio. For loans with a term of 15 years or shorter, MIP ranges from 0.45 percent to 0.95 percent. For loans with a longer term, MIP ranges from .80 percent to 1.05 percent.
If you get a Department of Veterans Affairs (VA)-backed loan, there’s no monthly mortgage insurance premium. However, you’ll pay an upfront ‘funding fee.’ The amount of that fee varies based on the type of military service, down payment amount, and disability status.
The Rural Development Administration of the Department of Agriculture guarantees low down payment mortgages to middle and lower income rural residents. The program is similar to FHA. Borrowers can roll the upfront portion of the insurance premium into the mortgage instead of paying it out of pocket, but doing so increases both loan amount and overall costs.
Canceling private mortgage insurance
One of the advantages of PMI is homeowners’ right under the Homeowners Protection Act to cancel their insurance policy when equity in the mortgage reaches 20 percent of the principal. Depending on changes in home values, the structure of the mortgage and the size of the down payment, reaching 20 percent equity can typically take two to five years.
Even if you don’t ask your servicer to cancel PMI, your servicer still must automatically terminate PMI on the date when your principal balance is scheduled to reach 78 percent of the original value of your home. For your PMI to be cancelled on that date, you need to be current on your payments on the anticipated termination date. Otherwise, PMI won’t be terminated until shortly after your payments are brought up to date.
The law doesn’t require cancellation of mortgage insurance on government-guaranteed loans like FHA, VA or USDA. For these government-backed loans, mortgage insurance is required for the life of the loan. Homeowners can terminate mortgage insurance for these loans only by refinancing with a conventional mortgage or selling the property.
To learn more about the different types of home loans, check the our resource on How to Finance.