If you're planning on making a smaller down payment on your next home or investment property, your mortgage lender will probably tell you that you will be required to have mortgage insurance, which can become part of your monthly payment. With that in mind, below is a guide to this type of insurance policy, including what it is and how it works.
What is mortgage insurance?
In short, mortgage insurance is a policy that protects the lender in the event that the borrower defaults on their home loan. Although it may seem strange, the lender usually requires the homeowner to take on this cost as a condition of being approved for their mortgage loan. Typically, mortgage insurance is a requirement if your down payment is only worth a small percentage of the home's purchase price.
Notably, mortgage insurance is different from home insurance, which protects your home's structure and its contents in the event of a destructive event like a fire or wind damage. It also differs from mortgage life insurance, which pays off your mortgage if you pass away, and from mortgage disability insurance, which pays off your mortgage if you become disabled.
What are the different types of mortgage insurance?
If you need mortgage insurance, it's important to know that the costs and fee structure will vary according to your loan type. To give you a better idea of what to expect, we've outlined them for you below.
Conventional loan: Private mortgage insurance (PMI)
While there are conventional mortgages out there with low down payment requirements, if your down payment is worth less than 20% of the home's purchase price, you'll likely be required to have PMI.
However, the big differentiator between PMI and other mortgage insurance programs is that you can request that it be canceled once you've built up some equity in your home. In fact, it's a good idea to call your mortgage servicer to make the request once your loan-to-value ratio falls below 80%.
FHA loan: Mortgage insurance premium (MIP)
The defining feature of a Federal Housing Administration (FHA) loan is that it allows for down payments as low as 3.5% and enables borrowers to have a lower-than-normal credit score. However, in exchange for that flexibility, the FHA charges a form of mortgage insurance known as a mortgage insurance premium.
Your FHA mortgage insurance will come with an annual premium and an initial upfront fee when you close on the home. Typically, the annual premium is worth between 0.45% and 1.05% of the average outstanding loan balance for the year. Meanwhile, the upfront fee usually amounts to 1.75% of the loan amount.
If you put down less than 10% of the home's purchase price as a down payment, you will have to pay FHA MIP for the life of the loan. However, if you put down more than 10%, you can cancel the mortgage insurance premium on your loan after 11 years.
U.S. Department of Agriculture (USDA) loan: Guarantee fee
Similar to an FHA mortgage, every USDA loan comes with an upfront fee and an annual premium. In this case, it is known as a "guarantee fee." This fee is updated each fiscal year, which runs from October 1 to September 30.
The upfront fee for the 2022 fiscal year will be equal to 1% of the loan amount, and the annual fee will equal 0.35% of the loan amount.
Veterans Administration (VA) loan: Funding fee
While a VA loan doesn't technically require a down payment or mortgage insurance, it does come with something called a "funding fee." The funding fee is a one-time charge that can be paid upfront or rolled into your mortgage loan amount.
Typically, this fee ranges from 1.4% to 3.6% of the loan amount. However, the exact fee you'll pay will depend on a number of factors, including the size of your down payment and whether this is your first VA loan.
The Millionacres bottom line
If you can't afford to make a large down payment, mortgage insurance may seem like a small price to pay to be able to own your own home. However, before this fee gets added to your monthly mortgage payment, it's important to understand how it works.
As you can see from the information above, much of your mortgage insurance cost will depend on your loan program. For example, with a conventional loan, you have the option of getting rid of your PMI cost once you've built up some home equity. However, with some government-backed loan options, it is not possible to get rid of the cost of mortgage insurance.
With that in mind, if you have questions about mortgage insurance and your specific real estate financing options, your best bet is to talk with a loan officer. They'll be able to give you more specifics about your mortgage insurance requirement and how it will affect your monthly payment.