When Do You Need Mortgage Insurance?

Curious about when mortgage insurance comes into play? Let's break it down: If you're fortunate enough to make a 20% down payment on your new home, you can skip the mortgage insurance ride. But don't fret if that's not on the horizon – there are other routes to explore. Specific lenders and government programs dish out mortgages with smaller down payments and zero mortgage insurance stress. Let's dive into the ins and outs of mortgage insurance and when it's on the table.

What is mortgage insurance?

Mortgage insurance serves as a bridge between your commitment to being a reliable borrower and the lender's need to manage risk. It involves purchasing insurance coverage to protect the lender when you cannot maintain mortgage payments.Typically, when your home down payment is less than 20%, many conventional loans require obtaining private mortgage insurance (PMI). These are conventional loans not backed by federal support.

This might entail an additional monthly expense to consider. If PMI is necessary, your lender will likely automatically include the PMI cost in your monthly mortgage payment. While the lender selects the mortgage insurance provider, your freedom to compare options is limited; nevertheless, you can inquire about a quote before finalizing your documentation.

Types of mortgage insurance

Here are the various types of mortgage insurance:

• Borrower-Paid Mortgage Insurance (BPMI):

Commonly referred to as PMI, this type is typically included in monthly mortgage payments. It usually ranges from 0.5% to 1% of your loan amount per year. This translates to an annual cost of $1,000 to $2,000 for the average U.S. homeowner with mandatory coverage. You can generally cancel PMI once your home equity surpasses 20% or at the midpoint of your loan term.

• Lender-Paid Mortgage Insurance (LPMI):

With LPMI, your lender covers your mortgage insurance upfront, resulting in a slightly higher mortgage rate, typically around 0.25% to 0.5% more. This option lowers monthly payments and often allows a reduced down payment, sidestepping the 20% requirement. However, opting for LPMI may lead to higher interest rates for those with lower credit scores, and the coverage remains in place unless refinanced.

• FHA Mortgage Insurance Premium (MIP):

Geared toward first-time buyers with government support, FHA home loans require purchasing mortgage insurance, known as mortgage insurance premiums (MIP). This involves an upfront fee (approximately 1.75% of the loan amount) at closing, along with an annual premium (ranging from about 0.45% to 1.05% of the loan amount). Unlike borrower-paid mortgage insurance, MIP doesn't automatically end; it continues unless you make a down payment of 10% or more, allowing you to remove MIP after 11 years.

Do USDA and VA loans have mortgage insurance requirements?

Prospective rural homebuyers who satisfy income eligibility criteria could discover mortgage options via the US Department of Agriculture (USDA). These zero-down-payment loans entail upfront and monthly fees in lieu of traditional mortgage insurance.

Additionally, the US Department of Veterans Affairs (VA) extends mortgage opportunities to present, disabled, and retired veterans, their qualifying spouses, active-duty National Guard members, and reservists. These loans involve associated fees, the extent of which hinges on factors like down payment size and borrower history. Notably, VA mortgage recipients typically settle the entire fee upfront.

Is mortgage insurance avoidable?

Typically, when purchasing a home and placing a down payment of under 20%, your lender will likely demand insurance from a PMI company before finalizing the loan. Despite the additional cost, PMI facilitates affordable financing for buyers who need help to afford a substantial down payment or opt not to make one. It's important to note that government-backed loans such as FHA and USDA loans also involve mandatory mortgage insurance, offering fewer avenues to avoid it.