If buying a home is your next financial goal, then you may have heard about mortgage insurance. Mortgage insurance is probably not what you expect it to be. We will cover what you need to know about mortgage insurance before you buy your future home.
What is mortgage insurance?
Mortgage insurance is a way for lenders to protect themselves from high-risk borrowers. The mortgage payments allow lenders to compensate for any losses due to defaulting on a mortgage loan.
When you think of insurance of any kind, you typically think that the insurance would help you in times of need. Instead, this helps mortgage lenders to limit the risk from borrowers, which allows for more lending to happen.
The mortgage insurance payments protect the mortgage lender. It does not protect you in any way if you fall behind on your monthly payments.
Mortgage insurance makes the home buying process more expensive for the borrower. However, it will make it possible for some to buy a home at all. If your down payment is less than 20%, then receiving a loan with mortgage insurance attached may be the best (and only) way to secure a home loan.
How Mortgage Insurance Works
As the borrower, you would need to pay extra money to the lender as a form of insurance. The method of payment can vary by lender.
You may need to pay an upfront fee or a monthly insurance payment that is added to your mortgage payment. Some lenders may even require both an upfront fee and an additional monthly payment.
The payment amount will vary widely based on your own credit, loan amount, and ability to pay the mortgage. Typically, low-risk borrowers will be entitled to lower mortgage insurance costs. High-risk borrowers should expect to pay a higher mortgage insurance premium.
The borrow is basically paying for the privilege of borrowing the money even though the borrower has a high associated risk.
Why would I get mortgage insurance?
Borrowers are required to pay mortgage insurance if they make a down payment of less than 20% of the home purchase price. Many federal programs like the FHA and USDA loans also require mortgage insurance as a part of the loan conditions.
If you are purchasing a home through a loan, your lender may require that you purchase mortgage insurance. You may have no choice in the matter if your lender dictates that you must purchase mortgage insurance to receive the loan.
It is generally not helpful for your financial situation to sign up for mortgage insurance. If you have the option to skip mortgage insurance, then that may be a good choice, depending on your situation. Otherwise, you will be paying for your lender to be protected, but you will not gain anything in the process.
Common Types of Mortgage Insurance
There are many kinds of home loans. Each type of loan has a slightly different type of mortgage insurance associated with it for some high-risk borrowers. We will cover the most common kinds below.
Conventional loans are typically offered through private companies. Depending on your down payment amount and your credit score, the private lender may require private mortgage insurance (PMI) as a condition of the conventional loan.
The amount of private mortgage insurance will also vary based on the down payment, loan amount, and your credit history. Higher credit scores and down payments will generally lead to lower required mortgage insurance premiums.
With private mortgage insurance, the premiums are usually paid out monthly with no initial upfront fee. You may also have the ability to cancel your private mortgage insurance in certain situations.
Department of Veterans’ Affairs (VA) Loans
If you are a service member or a veteran, you have likely heard of the VA loan. The idea is to help these honorable men and women purchase homes.
The VA will back your loan, so there are no monthly mortgage insurance fees required. However, you may need to pay an upfront funding fee that will act as mortgage insurance. The initial funding fee will vary based on your military history, down payment, credit score, and several other factors.
Although the upfront funding fee is not termed as mortgage insurance, the idea is the same.
US Department of Agriculture (USDA) Loans
USDA loans offer great mortgage rates meant to help low to moderate-income home buyers in rural areas. The hope is that these loans will help to infuse life back into rural areas.
The loans offer zero down payments to home buyers, but mortgage insurance is required. A USDA loan requires that you pay an upfront premium as well as monthly premiums.
Federal Housing Administration (FHA) Loans
FHA loans are insured by the Federal Housing Administration but are completed through private lending companies.
FHA loans offer another low down payment option for people with lower credit scores. However, there is an enforced maximum loan limit that varies by county.
Every loan insured by the FHA requires mortgage insurance. You pay the annual mortgage insurance premium (MIP) monthly for the life of the FHA loan. The upfront and monthly mortgage insurance premium amounts vary by loan, but you can expect to pay it with FHA loans.
See also: FHA Loan Requirements for 2023
Can I avoid paying for mortgage insurance?
The easiest way to avoid mortgage insurance is by making a down payment of 20% or more. Of course, this is not feasible for every situation. Depending on your current financial picture, you may need to pay for mortgage insurance to purchase a home.
Alternatively, you can request to have your PMI canceled once the equity in your home reaches 20% of the purchase price or appraised value.
Mortgage insurance is a required expense for many home buyers. If you are unable to make a 20% down payment on your home purchase, you will likely be required to pay for mortgage insurance.