Understanding Mortgage Insurance

Mortgage insurance is one of those costs that people want to avoid at all costs. But it's also what makes low down payment loans possible. Understanding how it works helps you decide whether paying it is worth buying sooner.

What it is

Mortgage insurance protects the lender, not you, if a borrower defaults. Because it reduces the lender's risk, it allows loans with smaller down payments.

The main types:

• Private mortgage insurance (PMI) on conventional loans
• Mortgage insurance premiums (MIP) on FHA loans
• VA loans don't have monthly mortgage insurance, but most borrowers pay a one-time funding fee unless exempt

Conventional PMI

PMI is generally required when you put less than 20% down on a conventional loan.

How it's priced

The cost depends on factors including:

• Credit score
• Down payment / loan-to-value
• Loan term
• Debt-to-income ratio, in some cases
• Coverage level required

Borrowers with higher credit scores and larger down payments generally pay less.

How it's paid

Most commonly, it's a monthly amount added to your payment. Other options can include a single upfront premium or lender-paid PMI built into a slightly higher rate. Each has trade-offs.

Removing PMI

This is a big advantage of conventional loans. Generally:

• You can request removal once your balance reaches 80% of the home's original value, if you meet requirements such as a good payment history.
• PMI is automatically terminated under federal law when your balance is scheduled to reach 78% of the original value, provided you're current.
• Some lenders allow removal based on a new appraisal if your home has appreciated or you've made improvements, subject to their rules and seasoning requirements.

FHA mortgage insurance

FHA loans include two kinds:

• An upfront MIP, usually financed into the loan
• An annual MIP, paid monthly

Depending on your down payment and term, annual MIP can last for a set number of years or for the life of the loan. Often the way to remove it is to refinance into a conventional loan once you have enough equity and qualify. More in FHA pros and cons.

Is paying mortgage insurance worth it?

It depends. Consider:

• How long it would take to save 20%: in California, that can be many years. Meanwhile, rents and home prices change.
• The monthly cost compared to the benefit of owning sooner.
• Your reserves: putting less down can leave more cash for emergencies.
• Removal options: conventional PMI that can come off in a few years is different from FHA MIP that may stay.

An example

These numbers are for illustration only. A buyer purchasing a $750,000 home could put 10% down now and pay, say, $250 a month in PMI. Alternatively, they could wait several more years to save 20%. If home values rise during that time, the 20% target grows too. Of course, values can also fall. There's no universally right answer, but it's worth running both scenarios.

The mortgage calculator has a field for mortgage insurance so you can see how it affects your payment. Enter an estimate from a quote rather than assuming.

Ways to reduce or avoid it

• Put 20% down on a conventional loan
• Improve your credit score before applying
• Use a VA loan if you're eligible
• Consider lender-paid PMI or a first and second mortgage combination, with their own trade-offs
• Make extra principal payments to reach removal thresholds sooner

Questions?

If you'd like a real mortgage insurance quote for your scenario, contact me, or start your pre-approval and I'll show you the options side by side.