How Much Is Mortgage Insurance?

Mortgage Points 4

    How Much Is Mortgage Insurance: Guide To Home Loan Insurance

    If you want to take out a mortgage, most lenders require a 20% down payment before you’d even qualify. Considering that the average property goes for $250,000, that’s out of most homebuyers’ budgets.

    However, there is a way around that down payment requirement; you can get mortgage insurance.

    In this guide, we’ll cover the following topics:

    • What is mortgage insurance?
    • Why would you need insurance on mortgage?
    • What types of insured mortgages are there?
    • What should you expect to spend on insurance premiums per month?
    • How can you reduce your monthly payment?

    Now, let’s get started.

    What Is Mortgage Insurance?

    Although homeowners are responsible for shouldering the cost of mortgage insurance premiums, it’s actually the lender who gets protected. In the event that you can’t pay your loan, mortgage insurance ensures that the lender can still recoup some of the losses. 

    This doesn’t take you off the hook for payments – you’re still obligated to pay off your debts – but it does put the lender more at ease, making them more likely to approve you for a loan. 

    In most cases, you won’t be able to take out a mortgage if you have less than 20% down payment. This is because mortgage lenders generally don’t want to assume that big of a financial risk. But if you get mortgage insurance, you can secure a home loan without having to spend years saving up for the down payment. This way, you can be a first-time homeowner as soon as possible and start building equity.

    Basically, what mortgage insurance takes into consideration is your loan-to-value ratio. To buy a home, you need an 80% LTV – you pay a 20% down payment, and the lender loans you the remaining 80%. Most mortgage insurance allows you to have a higher ratio of 80-95% LTV, meaning that you can take out a mortgage for as little as 5%. 

    Keep in mind that this is different from mortgage life insurance, which pays the remainder of the mortgage in case the borrower dies; and mortgage disability insurance, which gets rid of the debt in case the home buyer becomes disabled.

    Types Of Mortgage Insurance

    Mortgage insurance can be divided into two categories: private mortgage insurance (PMI) and mortgage insurance protection (MIP). Here is a breakdown of both.

    Private Mortgage Insurance (PMI)

    If you have a conventional mortgage, you may be required to buy private mortgage insurance. Most lenders will not loan you money if you have a down payment of less than 20% unless you secure a PMI as well. A PMI could also be a good idea if you do have a 20% down payment but would rather use it on other things like furnishings or repairs.

    The PMI varies depending on your down payment, mortgage size, credit score, and loan terms. Generally, it’s anywhere from 0.5-1% of the total loan amount per month, although some insurers may charge as much as 2.25% of the loan amount. 

    Once you hit an LTV ratio of 80% – that is, you’ve paid at least 20% of the total property value, including your down payment – you are no longer considered a high-risk borrower. You can (and should) cancel your PMI at that point. If you reach a 78% LTV, the lender is obligated to cancel your PMI automatically.

    There are a few different types of PMI:

    • Borrower-paid PMI: This is the most common type of PMI. If the insurer doesn’t specify what type of insurance you’re getting, it’s most likely borrower-paid. You pay a small premium every month on top of your mortgage.
    • Single-premium PMI: The insurance premium is paid in a lump sum upfront. If the full payment amount isn’t given by closing, the rest can be paid off alongside your mortgage. This lowers the monthly payment amount, but you won’t get any refunds if you refinance or sell your home within a few years. You can negotiate with the seller or even building contractor to pay off your private mortgage insurance as part of the deal.
    • Lender-paid PMI: The lender technically pays the mortgage insurance, but its cost is bundled into the price of the mortgage. You can’t cancel your lender-paid PMI even after you reach 20-22% equity, but the trade-off is lower premiums.
    • Split-premium PMI: This type combines single-premium and borrower-paid PMI. You still pay an upfront sum, although not as big as you would with single-premium insurance. You pay the rest off in monthly installments.
    ProsConsExample cost*
    Borrower-paid PMI- Common- Can cancel after reaching 20% equity- Higher monthly premiums$1,597.50 per year/$133 per month
    Single-premium PMI- Lower premiums- Can be paid by seller or contractor- Requires large upfront sum- No refunds if you refinance/sell within a few years$8,212.50
    Lender-paid PMI- Paid by lender- Lower premiums- Cost is bundled into mortgage- Can’t cancel after reaching 20% equityVaries depending on the lender
    Split-premium PMI- Lower premiums- Requires upfront sum$1,102.50 per year/$92 per month**

    *Calculated for a $250,000 home property value, an LTV of 90% ($25,000 down payment), a credit score of 720, 35% coverage, loan payable in 30 years. Using AnytimeEstimate figures.

    **With a 1% upfront payment.

    Mortgage Insurance Protection (MIP)

    If PMIs are for conventional home loans, MIPs are for government-backed Federal Housing Association (FHA) loans. If you have an FHA-backed mortgage, you are required to buy an MIP.

    MIPs are similar to single-premium insurance in the sense that you have to pay an upfront sum (UFMIP) and monthly premiums. Currently, the UFMIP is set at 1.75% of the total amount – for a $225,000 home loan, that’s almost $3,950. The annual mortgage payment is at 0.45%-1.05% of the loan amount minus whatever upfront payments you’ve already made. 

    Unlike a PMI, you can’t cancel your MIP once you reach 80% equity. It’s valid for as long as you have the FHA loan The only way to get rid of MIP is to refinance your loan into a conventional one. If your LTV is greater than 80% at the time of refinancing, you will have to get a PMI to cover the rest.

    Other Types Of Mortgage Insurance

    Both the USDA and VA have home loan programs where insurance is required. 

    In the case of USDA-backed loans, home buyers need to pay both an upfront fee (at 1% of the total loan amount) as well as an annual mortgage premium of 0.35% of the loan.

    The VA home loan doesn’t require mortgage insurance or even a down payment, but they do charge an upfront “funding fee” instead. The amount you pay every month depends on factors like your military service, down payment, and if this is the first time you’re taking out a VA loan or not.

    Is Mortgage Insurance Necessary?

    Not all home buyers have to get mortgage insurance. If you have a 20% down payment, you wouldn’t need mortgage insurance just to get approved for a conventional loan.

    However, if you have less than 20%, or if you’re being financed by the FHA or USDA, you’ll have to shell out for some sort of mortgage protection. For conventional loans, lenders require a PMI if you have an LTV ratio greater than 80%. For FHA and USDA-backed loans, your obligations include an upfront lump sum as well as recurring monthly payments.

    If you don’t want to pay mortgage insurance but can’t cough up enough money to meet the down payment requirement, an alternative is to get a piggyback mortgage or a second mortgage at the same time as your first. This allows you to borrow more money and meet the LTV ratio requirement to avoid PMI.

    How Much Does Mortgage Insurance Cost?

    Your mortgage insurance rate is calculated as a percentage of the total amount of your loan. How much you pay in monthly premiums depends on many factors, including:

    • Down payment: Increasing your down payment is one of the best ways to reduce the costs of mortgage insurance. The more you pay upfront, the less you’ll have to spend on insurance. 
    • Loan amount & terms: Bigger loans come with higher insurance premiums. Loan terms – or how long you have to pay the full amount – also factor in. Longer terms (e.g. 30 years) often have higher rates.
    • Credit score: Your credit score is one of the most important factors in determining your premiums. Improving your credit score will result in lower premiums – sometimes as much as 50%. This only applies to PMI; MIP doesn’t take this into consideration.
    • Coverage: Coverage refers to how much of the loan the insurer is willing to cover. Most companies provide up to 35% of the loan amount. For a $225,000 loan, that means that the lender is protected for up to $67,500 in case you can’t pay.

    Here’s a sample comparison for conventional, FHA, USDA, and VA home loans:

    ConventionalFHAUSDAVA
    Upfront costNone1.75%1%2.3%+
    Example upfront cost*None$4,375$2,500$5,750
    Annual insurance rate0.5-2.25%0.85%0.35%None
    Example annual insurance premium cost*$1,875**$2,125$875None
    Example monthly premium cost*$156**$177$73None

    *Calculated based on a $250,000 loan.

    **At a 0.75% annual rate.

    Your annual insurance rate is recalculated annually. Since you’re paying off your loan bit by bit, you can expect your PMI or MIP to get cheaper as time goes by. If you have a PMI, you can cancel your insurance as soon as you reach an LTV ratio of less than 80%.

    For MIPs, there’s no cancel date – you have to pay premiums until the entire amount is paid off. However, if you put more than 10% down (compared to the minimum 3.5%), you only have to pay the premiums for 11 years.

    When you receive a quotation from a potential insurer, the report should include:

    • Your mortgage insurance rate
    • How much your annual and monthly premiums are
    • How long it will take you to reach the 20% equity threshold to cancel your PMI

    How To Avoid PMI & Reduce Insurance Premiums

    Many financial advisors will tell you to avoid PMI as much as possible because it’s a waste of money. The best way to avoid it is to put down more than 20%. You can also try negotiating with the lender to see if they’ll approve your loan without a PMI.

    Here are other tips for lowering your monthly premiums or avoiding mortgage insurance altogether:

    • Take out two concurrent loans, also known as piggybacking. Use the second loan to cover what the first loan cannot.
    • Accumulate at least 20% equity of your home by paying off your mortgage, and then cancel your PMI.
    • Pay your mortgage until you have at least 22% equity; the lender is required to cancel your PMI automatically.
    • Improve your credit score. Higher scores mean lower rates.

    Conclusion

    Although most mortgage insurance is just a fraction of a percentage of your home loan amount, it can really stack up. It’s important to know the ins and outs of insurance and choose your insurer wisely – you could end up wasting thousands of dollars if you don’t.

    Wesley LLC can help you find the best rates. Contact us today and learn more!

    Written By Ed Wallace
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