Mortgage Insurance
Mortgage insurance protects the lender against loss if you default on your mortgage. If the borrower defaults and the lender must take title, the mortgage insurer reduces or eliminates the cost for the lender. Without this guaranty, lenders typically require the borrower make a down payment of at least 20% of the purchase price, which can be impossible for some borrowers.
There are several types of mortgage insurance, but the most common is private mortgage insurance, which is required on conventional loans with less than 20% down. All FHA loans also come with two types of mortgage insurance: an upfront premium and an annual premium.
In all cases, mortgage insurance is paid by the borrower. Depending on several factors, the cost of mortgage insurance is calculated off of the loan amount and can be from $50 to over $500 per month.
Who Needs Mortgage Insurance?
If your loan-to-value ratio is greater than 81% -- meaning you did not put down at least 20% on your home loan -- and you have a conventional mortgage, as opposed to a government-backed loan, you will need to pay for private mortgage insurance (PMI). You may also be required to carry PMI if you have a low credit score or the lender views you as a high risk, even if your LTV is 60% or 70%.
All FHA loans require mortgage insurance in two forms, explained below. Qualifying veterans who obtain a VA loan will never pay private mortgage insurance, regardless of the down payment.
The Cost of Mortgage Insurance
PMI is typically a percentage of the loan amount, usually between 1 and 2%. On a $150,000 mortgage, the annual cost of PMI will be around $1,500, or $125 per month. In general, the higher the loan-to-value ratio, the more costly the PMI premiums. A borrower who makes a 10% down payment with a 90% LTV may have a PMI of 0.75% of the mortgage amount, whereas a borrower with an 85% LTV may be charged 0.50%.
If you get an FHA loan, you will be required to pay an upfront mortgage insurance premium (MIP) of 1.75% of the loan amount, along with an annual premium that is paid monthly along with your mortgage payment and ranges from 0.70% to 1.30%.
How to Get Rid of Mortgage Insurance
In the past, FHA mortgage insurance used to drop off after five years or when the borrower got to a certain LTV ratio. This is no longer the case, and now mortgage insurance remains with an FHA loan for the life of the loan. The only way to get rid of it is refinancing out of the loan.
PTI is much easier to cancel. Once your equity passes 20%, either by paying down the mortgage or through appreciation, you may be eligible to drop private mortgage insurance. Your lender will want proof of the equity, which requires paying for an independent appraisal. This typically costs $350 to $500. Lenders are also required to automatically cancel PMI when your balance reaches 78%.
Mortgage insurance is often a necessary cost to purchasing a home without a hefty down payment. It is still important to know the terms of your mortgage and understand how to cancel the insurance so you can avoid paying it longer than necessary. Removing PMI, when the time comes, will also lower your monthly mortgage payment.
