Homebuyers are generally required to pay mortgage insurance if they make a down payment that’s less than 20% of the home’s purchase price.
Mortgage insurance may seem like just another expense when it comes to buying a home — one that you’d be better off avoiding.
But mortgage insurance is not a bad thing. In fact, for most first-time homebuyers, it’s what allows them to purchase homes at all, since they don’t need to save up a 20% down payment.
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How much you’ll pay in mortgage insurance depends on the type of loan product you use to buy your home. Before we delve into specifics, here’s a quick explainer on what, exactly, mortgage insurance is.
Lenders require mortgage insurance if you put down less than 20% when you buy a home. Why? Because the less money the borrower puts down, the greater the risk the mortgage lender takes on.
Borrowers who put down 20% start off with a substantial stake of equity in the home. They may be less likely to default because they have more skin in the game, so to speak. Additionally, the more you put down, the more manageable your monthly mortgage payment may be — and that can decrease the risk of default.
Homebuyers who put down less than 20% — and that’s most borrowers these days, as the median down payment in 2020 was 6%, according to the National Association of REALTORS® — pay mortgage insurance to offset the risk for lenders.
But it benefits homebuyers, too. Mortgage insurance enables lenders to give loans to worthy borrowers who can afford a monthly mortgage payment but haven’t been able to save up the traditional 20%. Down payment is often the biggest barrier to prospective homeowners, especially if they’re still paying down student loan debt or live in costly cities where rents are on the rise.
By offering lower down payment loan options, lenders can approve more borrowers for home loans. Mortgage insurance balances the risk for them, but it also creates opportunities for buyers.
Without mortgage insurance, many folks could be locked out of homeownership for years as they attempt to save 20%. In the meantime, they’re missing out on building equity in their homes, a key factor in wealth building in the U.S.
The type of mortgage insurance you’ll pay depends on your loan type. Keep in mind that lenders talk about mortgage insurance in “annual” terms. But you don’t pay it once per year. Lenders break up the annual amount into 12 equal installments. You pay it each month along with your mortgage payment
The different types of mortgage insurance are as follows:
- Conventional loans have an annual private mortgage insurance (PMI) premium
- FHA loans have an upfront and annual mortgage insurance premium (MIP)
- USDA loans have an upfront and annual mortgage insurance (MI) fee
- VA loans have an upfront funding fee, but no annual premiums
Upfront mortgage insurance fees are due at closing, though you may have the option to roll them into your loan instead. Annual premiums adjust each year based on your remaining mortgage balance, and, as mentioned, they are divided into 1/12th installments and included in your monthly mortgage payments.
Mortgage insurance on a conventional loan is known as private mortgage insurance (PMI). Conventional loan borrowers may qualify for a loan with as little as 3% down, as long as the home they’re buying will be their primary residence.
That means that on a $300,000 home, your down payment could be as little as $9,000 — far less than the $60,000 you’d need if you saved up for a 20% down payment to avoid PMI.
But what are the PMI costs? PMI rates are usually between 0.5-1.5% of your loan amount per year, broken up into 12 equal installments and paid monthly.
Your individual PMI rate will depend on your credit score and your loan-to-value ratio (LTV). LTV refers to your down payment vs your loan amount. So, if you put down 3%, your LTV is 97%, since that’s how much you’re borrowing.
If you opt for a conventional loan with less than 20% down, you’ll pay PMI until you reach 20% home equity. At that point, you can request PMI cancellation through your lender. Once you have 22% home equity, the PMI requirement falls off automatically.
Keep in mind, though, that servicers (the company to which you make payments) calculate LTV differently from one another. One may use your home’s current value, another may use the original purchase price. Check with your servicer on how it calculates your equity level.
If your servicer uses the original purchase price to calculate LTV, you may have to refinance to remove PMI earlier.
The U.S. government insures several mortgage programs that are offered through participating lenders. One of the largest is a Federal Housing Administration (FHA) mortgage. FHA loans require a minimum of 3.5% down if your credit score is 580 or above, and 10% if it’s 579 or below.
All FHA loans require upfront and annual MIP, regardless of down payment size. The upfront mortgage insurance premium is 1.75% of your loan amount, and it can be paid at closing or rolled into your loan.
Annual MIP rates range from 0.45% to 1.05%, depending on the purchase price of your home, the down payment, and the loan term.
If you put down 10% or more on an FHA loan, the annual MIP requirement ends after 11 years. But if you put down less than 10%, you will owe MIP for the life of the loan. Most FHA borrowers put down less than 10% and pay an annual MIP rate of 0.85%, which is about $177 per month on a $250,000 loan.
MIP RATES FOR A 30-YEAR FHA LOAN
|Loan amount||Down payment||MIP per year||How long you’ll pay|
|$625,000 or less||Less than 5%||0.85%||Life of the loan|
|$625,000 or less||5% – 9.99%||0.80%||Life of the loan|
|$625,000 or less||10% or more||0.80%||11 years|
|Greater than $625,000||Less than 5%||1.05%||Life of the loan|
|Greater than $625,000||5% – 9.99%||1%||Life of the loan|
|Greater than $625,000||10% or more||1%||11 years|
Bolded row is the most common scenario for FHA buyers
MIP RATES FOR A 15-YEAR FHA LOAN
|Loan amount||Down payment||MIP per year||How long you’ll pay|
|$625,000 or less||Less than 10%||0.70%||Life of the loan|
|$625,000 or less||10% or more||0.45%||11 years|
|Greater than $625,000||Less than 10%||0.95%||Life of the loan|
|Greater than $625,000||Between 10% and 22%||0.70%||11 years|
|Greater than $625,000||22% or more||0.45%||11 years|
Pro Tip: One strategy for those who don’t want to pay MIP for the life of their loan: you can refinance to a conventional loan once you have 20% equity in the house.
Loans backed by the U.S. Department of Agriculture (USDA) are available if you are buying a home in eligible rural and suburban areas and meet the income requirements. USDA loans, which have a 0% down payment requirement, are intended for low- to moderate-income homebuyers.
Borrowers pay an upfront mortgage insurance fee of 1% on USDA loans, though they can often roll this into their loans. The annual mortgage insurance fee for USDA loans is 0.35%, or about $29 per month, per $100,000 borrowed.
Keep in mind, the USDA annual fee rate is subject to change.
The annual USDA mortgage insurance fee is in place for the life of the loan. However, as with FHA loans, you can refinance to a conventional loan once you have 20% equity in the home.
Learn more: USDA Loans: A Zero-Down Loan For The Suburbs
Loans guaranteed by the U.S. Department of Veterans Affairs (VA) are available to veterans, actively serving members of the military, and eligible surviving spouses. VA loans have a 0% down payment option for borrowers with full entitlement benefit available.
The VA doesn’t have mortgage insurance, per se. Instead, you’ll be charged a one-time funding fee. The funding fee is a percentage of the purchase price that depends on the amount of your down payment and whether you’ve ever had a VA loan before.
Funding fees can be paid up front or rolled into the loan.
VA FUNDING FEES FOR FIRST-TIME BORROWERS
|Down payment||Funding fee|
|5 to less than 10%||1.65%|
|10% or more||1.40%|
VA FUNDING FEES FOR SUBSEQUENT HOME LOANS
|Down payment||Funding fee|
|5 to less than 10%||1.65%|
|10% or more||1.40%|
Upfront fees are paid one time at loan closing, and typically wrapped into the loan amount. The percentage is based on the loan amount.
Annual fees are based on the existing balance and are paid in 1/12 installments along with the mortgage payment.
Mortgage insurance can seem like one more cost among the plethora of costs that come up when you’re buying a house. But it’s important to understand the very real bright side of mortgage insurance.
Mortgage insurance gets you building equity in a home and generating personal wealth faster than you would by saving for a 20% down payment.
Since 1991, U.S. homes on average have risen in price at a compound annual growth rate of 4.1%, according to the Federal Housing Finance Agency (FHFA).
If you purchase a $300,000 home today and that trend continues, your home would be worth around $352,000 in four years — a gain of 17%. That rate of return rivals the stock market and is much better than rates of return in savings accounts or bonds*. And do we even need to say it’s much better than you’d do renting?
If you put 5% down on a conventional mortgage, you would pay about 0.96% of the loan amount each year for PMI, according to MGIC – about $2,700 per year. But after about 4 years, you’d have enough equity, using home appreciation plus loan pay-down, to refinance out of PMI altogether.
Sure, you paid around $10,800 in PMI over that four years. But you gained $52,000 in wealth through home appreciation. Plus, you paid down your loan by about $19,000 over that time. Even subtracting PMI costs, your real wealth soared around $60,000 in four years almost 6 times your PMI cost.
Many homebuyers think of PMI as a sunk cost. But when you dig into the numbers, it starts looking like a very solid investment.
There’s also a type of insurance called mortgage protection insurance (MPI). Don’t confuse this with mortgage insurance. It’s an entirely separate product, and it is not required to obtain a mortgage.
Instead, MPI is a type of life insurance a homebuyer can purchase to pay off a home loan in case of the borrower’s death. It goes directly to the lender and not your family, but it does relieve them of having to make home payments and can alleviate anxiety about losing a home amidst their grieving.
For many people, however, a standard life insurance policy is more advantageous, because the benefits go directly to your family, and they can choose how to use them.
The cost of MPI varies greatly, depending on your age and the mortgage amount. You’ll need to shop around to determine how much mortgage protection insurance will cost you.
Mortgage insurance is calculated as a percentage of the mortgage loan. Depending on the type of loan you have, you may owe both an upfront fee and an annual fee. Annual mortgage insurance premiums adjust each year based on your remaining loan balance.
The length of time you have to pay mortgage insurance varies depending on the type of loan you have. Conventional mortgages require private mortgage insurance (PMI) until the borrower has 20% equity in the home, after which you can request cancellation.
FHA mortgages and USDA loans require mortgage insurance payments for the life of the loan. If you have an FHA mortgage and put down 10% or more, however, mortgage insurance ends after 11 years.
VA mortgages require a one-time funding fee. While this can be rolled into the mortgage cost and paid over the life of the mortgage, you can also pay it upfront. First-time VA borrowers who put 0% down pay a 2.3% funding fee.
USDA annual mortgage insurance continues for the life of the loan.
MPI, or mortgage protection insurance, is a type of insurance that pays off your house to the lender if you die. It is very different from the mortgage insurance that allows you to get a home with a lower down payment. It is not a required insurance in the home-buying process.
Mortgage insurance does add costs to your housing payment. But it is worth it, as it allows you to get a home with a low down payment and begin building equity sooner.
Because mortgage insurance amounts and requirements vary among types of loans, it’s important to factor in the pros and cons of each as you decide upon a house and a home loan.
When you get preapproved for a mortgage, your lender will tell you which loan products are available to you and the mortgage insurance costs for each so you can make the right decision for yourself.
Fairway is not affiliated with any government agencies. These materials are not from the VA, HUD, FHA, USDA, or RD, and were not approved by a government agency. The hypothetical figures in this article are for educational purposes and are only estimates. Fairway does not guarantee a mortgage loan will result in equity gains or tax advantages. Any potential benefits from homeownership are based on individual factors. Please consult a loan officer for your specific situation.
*The information in this article does not constitute financial planning advice. These are hypothetical figures, please consult a financial planner regarding your specific situation.
**Pre-approval is based on a preliminary review of credit information provided to Fairway Independent Mortgage Corporation, which has not been reviewed by underwriting. If you have submitted verifying documentation, you have done so voluntarily. Final loan approval is subject to a full underwriting review of support documentation including, but not limited to, applicants’ creditworthiness, assets, income information, and a satisfactory appraisal.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.