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Mortgage Insurance: Definition, Different Types And Cost

Victoria Araj5-minute read

December 02, 2020

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It’s important to understand the costs you’ll be responsible for when you buy a home. One of those expenses might be mortgage insurance. We’ll walk you through the different types of mortgage insurance, how long you’ll have to have it, approximate costs and whether you can avoid it.

What Is Mortgage Insurance?

Mortgage insurance is a type of insurance that protects the lender in case you default on your home loan. Because private mortgage insurance (PMI) mitigates risk to the lender, it allows folks with less-than-perfect credit scores or sizable down payments to purchase a home.

Generally, if you put less than 20% down on a home, most conventional loan lenders will require you to purchase PMI. A conventional loan is a loan that isn’t backed by the federal government.

Mortgage insurance is an additional monthly expense you’ll need to consider. Your lender will likely include your PMI expense in your monthly mortgage payment automatically. The lender oversees selecting the mortgage insurance company, so you won’t be able to shop around, but you can ask for a quote before you finalize your paperwork.

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How Much Is Mortgage Insurance?

Mortgage insurance costs depend on the type of insurance you have. On average, you can expect to pay .05% – 1% of your home loan amount in PMI.

Your premiums for PMI will depend on: 

  • Your PMI type
  • Whether the interest rate is fixed or adjustable
  • Your mortgage term – the length of your home loan
  • Your loan-to-value (LTV) ratio
  • The insurance coverage amount required by your lender
  • Your credit score
  • Your home’s value
  • Whether the premium is refundable
  • Additional risk factors, which will be determined by your lender

For instance, if you have a low credit score and only put down a 3% down payment, you’ll likely pay a higher amount for your mortgage insurance than a buyer with a better credit score who put down more money on the same home.

How Is Mortgage Insurance Calculated?

Lenders will calculate your PMI rate, generally .05 –1%, based on several factors to determine risk. These factors include your credit score, down payment amount and existing loans. The mortgage insurance company will tell you what your premium will cost.

If you want to make a conservative estimate before applying for a loan, it’s best to expect a 1% rate. Your premium will be recalculated every year as you pay off your principal, so expect it to decrease with time.

Let’s say you put 5% down on a $200,000 home, leaving you with a $190,000 conventional loan. If the mortgage insurance company is charging you 1%, your annual PMI payment is $1,900. Your lender will likely consolidate the monthly PMI fee of $158.33 along with your mortgage payments.

Alternatively, use our mortgage calculator to get an estimate that includes property taxes, homeowners insurance and mortgage interest.

How Long Do You Need To Have Mortgage Insurance?

The good news about PMI is that in most cases, you won’t have to continue paying on it for the entire length of your home loan. Most mortgage insurance plans allow you to cancel your policy once you’ve paid off more than 20% of the full loan amount of your home.

Typically, your lender would remove it once you have 22% equity. We suggest looking ahead to find out when you’ll have made it to the 20% benchmark to request a PMI cancellation and avoid paying unnecessary premiums.

Some mortgage insurance types require upfront payments that are also refundable when your mortgage insurance is canceled. Let’s walk through the different types of mortgage insurance to learn more.

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What Are The Different Types Of Mortgage Insurance?

There are different types of mortgage insurance you should be aware of – here’s a quick overview of each type.

1. Borrower-Paid Mortgage Insurance

In most cases, your PMI will be borrower-paid mortgage insurance (BPMI). When lenders talk about PMI, this is usually the type they’re referring to. BPMI is the type of mortgage insurance that’s rolled into your monthly mortgage payment.

Let’s break down how it could affect your costs. Typically, you’ll pay about .5% – 1% of your loan amount per year for PMI. This translates to $1,000 – $2,000 per year in mortgage insurance, or about $83 – $166 per month.

You can cancel the insurance after you have paid more than 20% of the home’s value. For single-family homes, this occurs when you have reached 78% LTV ratio, which means you have paid off 22% of the value of the loan or when you have reached the midpoint of your loan term – 15 years for a 30-year mortgage. 

2. Lender-Paid Mortgage Insurance

Lender-paid mortgage insurance (LPMI) means your lender initially pays your mortgage insurance, but your mortgage rate is higher to compensate for that lender payment. The interest rate increase is typically .25% – .5% more for LPMI. You’ll save on monthly payments and you’ll have a lower down payment because you’re not required to have 20% down with LPMI.

The lower your credit score, the higher your interest rate will be. LPMI will cost you more if you have a low credit score. Also, you’ll never be able to cancel LPMI because it’s built into your payment schedule for the entire loan term.

3. FHA Mortgage Insurance Premium

We’ve covered the types of mortgage insurance options for conventional loans, but what about government-backed home loans? Most FHA home loans, which are first-time home buyer loans financed through the federal government, also require the purchase of mortgage insurance, called a mortgage insurance premium (MIP).

In most cases, you pay mortgage insurance for the duration of your loan term unless you make a down payment of 10% or more (in which case, MIP would be removed after 11 years). You pay a couple of ways. First, an FHA loan upfront mortgage insurance premium (UFMIP), which is usually about 1.75% of your base loan amount.

Next, you’ll also pay an annual mortgage insurance premium. Annual MIP payments run approximately .45% – 1.05% of the base loan amount.

MIP works similarly to borrower-paid mortgage insurance, but it has a few key differences. Like BPMI, you’ll pay a monthly amount, typically rolled into your mortgage payment.

Here’s how it could work: You’ll pay an upfront payment that is 1.75% of the loan amount. If your home loan is for $200,000, expect to pay $3,500 at the time of closing. Expect to pay an average of .85% of your home loan for MIP throughout the duration of your mortgage. This percentage can run higher, depending on how much of a down payment you put down on your loan.

How To Avoid Mortgage Insurance

There are two government-backed mortgage types that do not require mortgage insurance: USDA loans and VA loans.

USDA Loans

USDA home loans are for buyers who purchase a home in a rural area. These loans are financed through the United States Department of Agriculture and do not require private mortgage insurance – no matter your down payment amount. You must pay an upfront fee of 1% of your loan amount and an annual .35% fee that will serve as a replacement for mortgage insurance payments.

VA Home Loans

VA home loans are for buyers who currently serve in the military, used to serve in the military or are a qualified spouse. These loans have no down payment options and no mortgage insurance requirements. You will need to pay an origination fee to cover processing costs – typically 1% of the loan amount. This fee can often be rolled into the loan.

It’s important to note that there's a funding fee between 1.4% – 3.6% of the loan amount that exists to offset the cost of the VA loan program. The percentage depends on several factors including: Whether it's a purchase or a VA Streamline refinance, service status, down payment and whether it's the first time obtaining a VA loan.

The VA makes exceptions for veterans and servicemembers who are eligible for or already receiving compensation for a service-connected disability; surviving spouses who meet the eligibility requirements; and active duty service members who have been awarded the Purple Heart.

Summary

Mortgage insurance is an extra expense you should plan to pay if you opt for a conventional loan and put less than 20% down on your home. Mortgage insurance offers greater access to homeownership for borrowers who are unable to pay 20% on a down payment.

That’s because PMI protects the lender if you default on your loan. In many instances, mortgage insurance can be canceled once you pay off 20% of your home’s value.

There are different types of mortgage insurance that you should be familiar with, including:

  • Borrower-Paid Mortgage Insurance (BPMI): You’ll pay mortgage insurance throughout your mortgage term.
  • Lender-Paid Mortgage Insurance (LPMI): Your lender pays your mortgage insurance – but you get a slightly higher mortgage rate.
  • FHA Mortgage Insurance Premium (MIP): You’ll be asked to pay a mortgage insurance premium (MIP) – but USDA loans and VA loans do not require mortgage insurance.

Check with your lender to find out which types of mortgage insurance they require and the terms that go along with their policies. Rocket Mortgage® by Quicken Loans® is here to help you make the right choice.

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Victoria Araj

Victoria Araj is a Section Editor for Quicken Loans and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.