Mortgage insurance: Your quick guide to different types and cost

Buying a home and taking on a mortgage is a big responsibility. You need to consider all of the costs of homeownership, not just the cost of your mortgage’s principal and interest payment. You should keep things like maintenance, utilities, and insurance in mind.

One cost that you may have to pay, particularly if you’re getting a loan with a low down payment, is mortgage insurance. We’ll discuss what mortgage insurance is, how it works, and how you may be able to avoid this extra cost.

What is mortgage insurance?

Mortgage insurance reimburses lenders for their losses if the borrower defaults on the loan. Note that mortgage loan insurance protects lenders, not you as the borrower.

The most common type of mortgage insurance is private mortgage insurance, which is required when you take out a conventional loan with a down payment of less than 20%.

Government-backed programs such as Veterans Affairs loans, Federal Housing Administration loans, and U.S. Department of Agriculture loans may require borrowers to pay for other types of mortgage insurance.

Private mortgage insurance explained

PMI is required when you get a conventional loan with a down payment of less than 20% of the purchase price. PMI applies both to purchase loans and refinance loans.

For example, if you buy a home for $500,000 with a $50,000 down payment, you’d have 10% home equity and would need to pay for PMI. If you decide later to If you refinance and your home is worth $550,000, and you owe $375,000 on your original mortgage, you’d have about 32% equity in the new loan and would not need to pay PMI.

You only have to pay for PMI as long as you have less than 20% equity. You can request your lender cancel your PMI payment as soon as you pay down your loan-to-value ratio to 80%. Your lender also will automatically cancel PMI when you have 22% equity in your home or at the halfway point of your loan term.

How much is mortgage insurance?

PMI generally costs between 0.1% and 1% of the amount borrowed each year. So, if you get a mortgage for $240,000, you can expect to pay between $240 and $2,400 per year for PMI. That amount would be paid monthly, so it would add between $12 and $120 per month to your mortgage payment.

Someone with strong credit who makes a larger down payment, such as 10%, will likely pay less for PMI because they pose less risk.

How borrowers pay for PMI

Most lenders will add your PMI payment to your monthly mortgage payment. It’s important to consider the cost of PMI when calculating your mortgage payment.

In rare cases, you may be able to pay for PMI up front, but the cost can be high.

It’s also worth noting that shopping around usually won’t save you money on PMI, but it’s still important to ask your lender about the cost of PMI before agreeing to a loan.

The 4 types of PMI

While all types of mortgage insurance aim to protect the lender from a borrower’s default, there are a few different types of policies. The differences usually manifest in how they are paid.

1. Borrower-paid PMI

Borrower-paid mortgage insurance is the most common type of PMI. This type of PMI is paid by the loan borrower and added to your monthly mortgage payment.

For example, if the principal and interest payment for the loan is $3,000 and PMI costs $300 per year, the borrower will have to pay $3,025 per month.

2. Single-premium PMI

Single-premium mortgage insurance also is paid by the borrower. The difference is that the whole cost of PMI is paid up-front at closing. That means that there are no monthly payments to make.

This can be useful for people who want to reduce their monthly payments, but it does require a potentially larger payment at closing. You could lose money if you sell the home quickly because you paid for the whole length of the PMI policy upfront rather than every month.

3. Split-premium PMI

Split-premium mortgage insurance is a hybrid of borrower-paid and single-premium mortgage insurance. You pay for some of the PMI policy upfront at closing and pay the rest as a reduced amount added to your mortgage payment each month.

This can be a good option if you don’t have the full amount to commit to a single-premium mortgage insurance policy but still want to reduce your monthly payment.

4. Lender-paid PMI

Lender-paid mortgage insurance, as the name implies, is a type of PMI where the lender, rather than the borrower, pays for the policy. Lenders usually compensate for this by increasing the interest rate of the mortgage.

For example, you may be able to get a loan at 7% with borrower-paid PMI, but if you choose lender-paid mortgage insurance, you may pay a mortgage rate of 7.5%. The increased rate, which you would pay for as long as you have the loan, would likely cost more than paying for PMI yourself.

How to avoid PMI

PMI increases your monthly mortgage bill but doesn’t help you pay off the loan any faster. It’s in your best interest to either eliminate PMI or avoid it in the first place if possible.

Make a larger down payment

PMI is required when you get a conventional mortgage with a down payment of less than 20% of the home’s value. That means that making a larger down payment is the most obvious way to avoid paying for PMI.

Get a loan that doesn’t require mortgage insurance

Another option is to get a loan that doesn’t require mortgage insurance. Most of these loans are government loans that are designed for specific borrowers.

For example, VA loans and USDA loans have no mortgage insurance requirements. However, to be eligible for a VA loan¹, you must be an active-duty military personnel, a veteran, or the surviving spouse of one. For a USDA loan, you need to be a low- to mid-income borrower buying a home in a specific rural area.

These loans also have fees that conventional loans do not. VA loans may require the borrower to pay a funding fee, and USDA loans require a guarantee fee. Rocket Mortgage® does not offer USDA loans at this time.

Cancel PMI when you have 20% equity

If you get a loan with PMI, you can ask the lender to cancel the payments once you have 20% equity. Lenders typically cancel PMI automatically if you reach 22% equity based on the purchase price of the home. If your home gains value, you may be able to cancel PMI sooner by refinancing² into a new loan.

Review your lender’s PMI disclosure, which should outline the steps you can take to ask the lender to cancel PMI. Usually, you’ll need to provide evidence that you’ve reached 20% equity, such as by offering a professional appraisal that shows your home has increased in value by enough to put you at 20% equity or greater.

PMI vs. mortgage protection insurance

It’s important to understand the difference between PMI, which protects the lender if you default, and mortgage protection insurance, which protects the borrower and their family.

MPI is a voluntary insurance policy that you can purchase. Usually, MPI pays out if you die, paying off your remaining mortgage balance so your surviving family can remain in the home. Some policies also offer partial payments for loss of a job or disability.

As with PMI, costs for MPI will vary based on the loan amount and other risk factors.

While MPI can offer peace of mind for your family, it is an additional cost and monthly payment to consider. It’s also not as flexible as other forms of insurance that your family could use to cover your mortgage costs, such as life insurance or disability insurance.

FHA mortgage insurance premiums

Federal Housing Administration loans help first-time buyers and other borrowers qualify for loans with a lower credit score and down payment. They require borrowers to pay an upfront and an annual mortgage insurance premium.

All FHA loans require an up-front mortgage insurance premium payment of 1.75%. The annual MIP payment is based on the down payment amount and the loan amount.

Ongoing MIP payments last for a period based on the size of the down payment you’ve made. If your down payment is less than 10%, you pay MIP for the entire loan term. If it’s more than 10%, you pay it for 11 years. The only way to remove MIP before its scheduled end date is to refinance.

How MIP works

Imagine you want to use an FHA loan to buy a home. You plan to borrow $400,000, choose a term of 30 years, and can make a down payment of 10%.

All FHA loans have an upfront MIP payment of 1.75%, so you would need to make an upfront payment of $7,000. You could either make this payment at closing or roll it into your loan’s initial balance.

Based on your down payment and mortgage amount, the ongoing MIP would be 0.5% of the loan amount each year. In the first year, that would cost $2,000 per year or $166.67 per month. MIP payments would end after 11 years of payments.

Depending on how much you’re borrowing and the size of the down payment, ongoing MIP can range from a low of 0.15% of the loan amount to a high of 0.75% of the loan amount, but is usually in the range of 0.4% to 0.55%.

FAQ

Here are answers to common questions about mortgage insurance.

What does mortgage insurance cover?

If you default on your mortgage, mortgage insurance reimburses the lender for losses related to your failure to pay the loan.

How long do I need to have mortgage insurance for?

The duration of mortgage insurance payments depends on several factors, including the type of loan, the amount borrowed, and the amount of home equity. With PMI, you can cancel payments once you reach 20% equity or the midpoint of the loan’s payment schedule. FHA MPI payments can last for 11 years or the entire length of the loan.

Do USDA loans require mortgage insurance?

USDA loans do not require mortgage insurance, but do come with up-front and annual guarantee fees. The upfront fee is no more than 3.5% of the loan amount. The annual fee is no more than 0.5% of the loan’s principal.

Do VA loans require home mortgage insurance?

VA loans are home loans designed for military members, veterans, and their families. They have no down payment requirement and do not require mortgage insurance, but do have a one-time funding fee. The fee ranges from 1.25% to 3.3% of the loan amount, depending on the down payment and the number of times you’ve used your VA loan benefit.

Is PMI tax-deductible?

No. The PMI deduction expired in 2021.

The bottom line: Mortgage insurance makes homeownership more accessible

Mortgage insurance reduces the risk that lenders face, allowing them to offer loans to people who can’t afford large down payments. That makes homeownership more accessible for many people, but it’s important to understand that PMI increases the cost of your loan and to factor that into your affordability calculations.

If you’re ready to buy a home, get started on your application with Rocket Mortgage.