What Is Mortgage Insurance? | Bankrate

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What is mortgage insurance?

Mortgage insurance is an insurance policy that protects the mortgage lender in case you are unable to pay back your mortgage. It’s typically required when borrowers make lower down payments. When someone has less invested in the home upfront, the lender takes on more risk in issuing the mortgage. Mortgage insurance helps cover that risk.

Although it covers the lender, and the lender chooses the insurer and the policy, the borrower pays for mortgage insurance.

Types of mortgage insurance and other fees

The type of mortgage insurance you’ll need depends on the type of loan you have. Options include:

• Private mortgage insurance (PMI): If you put less than 20 percent down on a conventional loan, you’ll pay PMI as part of your monthly mortgage payment.
• FHA mortgage insurance premium (MIP): All FHA loans require MIP, which involves a monthly payment as well as an upfront payment that can be rolled into your loan amount.
• VA funding fee: VA loans don’t technically require mortgage insurance, but you will need to pay a funding fee at closing — or roll it into your loan balance.
• USDA guarantee fee: Similar to the VA funding fee, you’ll need to pay a guarantee fee to get a USDA loan. There’s both an upfront fee and an ongoing fee.
• Mortgage title insurance: Title insurance protects various parties against liability if there’s an ownership dispute or title defect during a home purchase. Lender’s title insurance protects the lender, and owner’s title insurance protects the owner.

How does mortgage insurance work?

Different types of mortgage insurance have different requirements and durations.

For example, with a conventional mortgage, you’ll pay mortgage insurance as part of your mortgage payment. You can request to cancel PMI once you have 20 percent equity in your home. It will be automatically canceled once you have 22 percent equity.

With an FHA loan, everyone pays mortgage insurance, no matter the size of the down payment. You’ll pay both upfront MIP and annual MIP. If you make a down payment of less than 10 percent, you can’t cancel MIP – you’ll pay it for the life of the loan. If you put down 10 percent or more, you’ll pay annual MIP for 11 years, or until you refinance or sell.

Even with mortgage insurance, you could lose your home to foreclosure if you fall behind on your payments.

How much does mortgage insurance cost?

The cost of mortgage insurance depends on factors such as:

• The type of mortgage
• The loan size
• The loan term
• Your initial down payment
• Your credit score

Let’s break it down by loan type, using a $400,000 mortgage as an example:

Pros and cons of mortgage insurance

It’s pretty clear how this coverage benefits the lender, but how does mortgage insurance work for the borrower? Here are the main pros and cons.

Pros of mortgage insurance

• Don’t need to put 20 percent down to get a mortgage
• Start building equity more quickly
• More money to spend on other things, such as furniture or initial repairs, instead of putting it toward a larger down payment

Cons of mortgage insurance

• Extra expense to pay
• Can be hard or impossible to cancel, depending on the loan type
• Protects the lender, not you

What borrowers should know about mortgage insurance

As the cost of homes continues to rise, it’s becoming harder and harder to afford a mortgage payment — let alone to put 20 percent down on a home. If paying mortgage insurance helps you get into a home more quickly — or if saving 20 percent is nearly impossible on your budget — it’s likely worthwhile, even if it costs a little more.

However, if you really don’t want to pay for mortgage insurance, and you can’t afford to put 20 percent down, you may explore a couple of options:

• Down payment assistance programs can offer help with upfront homeownership costs in the form of grants or low-cost loans. Some offer mortgages that don’t require mortgage insurance.
• A piggyback loan involves getting two mortgages to pay for your home: one for 80 percent of the home price, and one for 10 percent. The second, smaller mortgage covers part of the down payment. Finally, you’ll make a down payment of 10 percent, bringing you to a 20 percent down payment. Before choosing a piggyback loan, do the math versus the cost of PMI to ensure you’ll save money.

FAQ

• Is mortgage insurance tax-deductible?
  

  No. The itemized deduction for this cost has expired. Unless legislation renews it, you won’t be able to claim a tax perk for mortgage insurance premiums.

• What is the difference between mortgage insurance and homeowners insurance?
  

  Mortgage insurance protects the lender if you stop paying your mortgage. Homeowners insurance protects you if you experience a covered loss, for example, if your house burns down in a fire or your home is damaged or destroyed by a tornado.

• What happens if I stop paying mortgage insurance?
  

  You can’t simply stop paying for the insurance policy, even if you’ve reached the required level of equity. You must first contact your lender to get the mortgage insurance policy canceled. However, by law, lenders must cancel PMI on conventional loans when you’ve reached a 78 percent LTV ratio.