What is Mortgage Insurance: Everything You Need to Know About

Mortgage Insurance

This is a comprehensive guide explaining mortgage insurance.

The best part?

We’ll demystify what mortgage insurance is, whether you need it, and how to get the best rates – even if you have a low down payment or credit score.

If you’re a first-time homebuyer trying to navigate the complex mortgage process, or you want to refinance but don’t understand mortgage insurance requirements, then this guide is for you.

Ready to dive in? 

Let’s start!

What Is Mortgage Insurance?

Mortgage insurance, often referred to as private mortgage insurance or PMI, is an additional insurance policy some lenders require to protect against losses if a borrower defaults on their home loan. It insures the lender – not you or your property – in the event you are unable to make your mortgage payments as originally agreed upon. 

This type of insurance comes into play when buyers are unable to make a down payment of at least 20% at the time of home purchase. By putting down less upfront to secure the loan, buyers are at higher risk of owning more than the home is worth if values decline, which could incentivize walking away and mortgage default. Mortgage insurance helps lenders mitigate that risk exposure to potential losses.

Private mortgage insurance is typically required on conventional home loans when buyers make a down payment of less than 20 percent of the purchase price. It is important to understand exactly what private mortgage insurance entails so you can navigate common requirements and work toward eventually removing the expensive premiums from your monthly payments.

Types of Mortgage Insurance

There are several forms of mortgage insurance you may encounter depending on the specific type of home loan:

1. Private Mortgage Insurance (PMI)

There are several major providers for private mortgage insurance (PMI) on conventional loans requiring less than 20% down:

• MGIC: Mortgage Guaranty Insurance Corporation, one of the earliest entrants in MI industry founded in 1957 based in Wisconsin.
• Radian Guaranty: Leading MI and risk management firm headquartered in Philadelphia with operations dating back to 1972.
• Genworth Mortgage Insurance: Genworth has been providing competitive mortgage default insurance products since 1981. Headquartered in Raleigh, North Carolina, they have insured over 20 million mortgages allowing low down payment buyers to enter home ownership.
• United Guaranty: Among largest mortgage insurers in US providing protection for over 40 lenders across an array of lending programs. A subsidiary of global insurer AIG with 40+ years of experience.

2. FHA Mortgage Insurance Premiums

Government-backed Federal Housing Administration home loans require both upfront and annual mortgage insurance premiums, paid to the FHA. Typically the upfront mortgage insurance premium is financed into the total loan amount at closing. The annual premiums tack on several hundred dollars each month that buyers pay for the life of the FHA loan.

3. VA Funding Fees

Instead of PMI or FHA premiums, loans backed by the Department of Veterans Affairs through programs like the VA home loan program require a one-time upfront funding fee deposited to the Veteran Affairs Department’s Loan Guaranty Service, rather than monthly premiums. The fee varies by factors like your down payment and military service.

What is Hazard Insurance on a Mortgage?

Along with mortgage insurance, lenders also require something called hazard insurance to protect the physical property that serves as collateral on home loans.

Hazard mortgage insurance goes by other names like homeowners insurance, property insurance, or casualty insurance. But they all refer to coverage protecting the home itself against damage or destruction to the physical structure from hazards like fires, storms, floods, falling objects, explosions, and vandalism.

Mortgage hazard insurance coverage is mandatory for most mortgage loans in the US to ensure the collateral itself – the new home – retains its value to secure the debt. Since lenders have a vested interest in homeowners properly maintaining and protecting their largest asset, keeping current hazard mortgage insurance is stipulated right in the mortgage contract and required before they’ll agree to loan closing.

The lender does not actually take out or hold the policy themselves. But rather loan contracts require the borrower to take out adequate hazard insurance on their new property with the lender listed as additionally insured on the policy. This protects their collateral position.

Unlike mortgage insurance, mortgage hazard insurance does protect the homeowner themselves by covering repair costs in case of covered disasters, big or small. Deductibles apply but it saves owners from totally shouldering complete rebuilding costs in a worst case scenario.

Maintaining hazard insurance simply remains table stakes to hold a mortgage, providing security to both lender and homeowner alike. Speak with your lender to ensure adequate limits and coverage.

How Mortgage Insurance Works

Mortgage insurance protects the mortgage lender, not you or the actual property itself. Some key things to understand about how it functions include:

• Required when you don’t make a 20 percent down payment.
• Provides coverage for the lender if you fail to repay your mortgage as originally agreed upon.
• Most mortgage insurance stays in place for a set period of time based on your loan or until you hit key thresholds regarding home equity through appreciation or additional payments .
• Premium expense gets tacked onto your total monthly mortgage payment.
• Annual premium rates cannot exceed 0.55 percent of your outstanding loan balance.
• Deductibles may apply in the event of default before the insurer covers losses.

For most borrowers purchasing a home, your mortgage lender will determine if mortgage insurance, through either private mortgage insurance or other programs like FHA, is required as part of the loan approval process based on your specific financial situation and loan product. 

Generally speaking mortgage insurance aimed to protect the lender from potential losses comes into play when buyers put down less than 20% at closing.

How Is Mortgage Insurance Calculated?

Mortgage insurance comes at a real cost to home buyers in the form of monthly premiums added to your housing payment. Buyers must abide by these expensive premiums for months or sometimes years depending on personal circumstances and loan details. 

But what goes into determining that widely dreaded monthly mortgage insurance rate?

Private Mortgage Insurers generally utilize similar risk-based pricing models to determine your unique mortgage insurance rate based on a range of personal factors like:

• Your FICO credit score: Buyers with higher scores present less risk and typically enjoy lower rates.
• Loan-to-Value (LTV): ratio based on down payment vs purchase price and home appraisal. The more equity upfront, the lower mortgage insurance rates drop.
• Loan type: ARM loans traditionally get assigned higher rates than fixed-rate products
• Property type: Single family, condo, multi-family homes, manufactured housing etc.

The specific mortgage insurer providing coverage such as MGIC, Radian, Genworth etc. Each has their own pricing models.

Federal Housing Administration mortgage insurance premiums depend primarily on the amount you finance, loan term, LTV ratio, and type of property securing the loan. On average FHA rates fall around 0.85 percent of loan balance annually.

Let’s take a look at some examples across loan types to better understand potential costs:

Private Mortgage Insurance Premium Estimates 

• $250K Home Price – 10% Down Payment ($25K): ~$150 per month PMI with average credit.
• $350K Home Price – 5% Down Payment ($17.5K): ~$400 per month PMI with good credit.

FHA Loan Estimates

• $200K Loan at 96.5% LTV – Upfront Mortgage Insurance Premium of 1.75% of loan amount + 0.845% Annual Premium = ~$150/month in just annual premiums alone.

Pros and Cons of Mortgage Insurance

Mortgage borrowers often have very strong feelings regarding mortgage insurance given the direct impact monthly premiums can have on housing budgets and personal finances. But there are worthwhile pros and cons to weigh regarding mortgage insurance:

Potential Pros

• Makes home ownership possible for buyers who lack the substantial down payment funds typically required for conventional loans. Bankrate estimates over 5 million new mortgages utilize mortgage insurance annually.
• Avg mortgage rates lower than alternative products like 80-10-10 or piggy back loans that blend two mortgages without insurance.
• Mortgage may be successfully closed faster due to relaxed lending requirements vs waiting to accumulate full 20 percent down.
• Provides home ownership opportunities to buyers that may not yet qualify for other programs like VA loans.

Potential Cons

• Hundreds per month average in insurance premiums protecting the lender, not you. Tack on costs can number $70-150K+ over the lifetime of the loan.
• Locks you into potentially expensive premiums for years depending on circumstance and cancellation clauses.
• Seriously delays ability to recast/refinance mortgage when still required months or years later.
• Ties up household income that could otherwise go toward things like retirement savings or other goals.

How to Pay Mortgage Insurance Premiums

As outlined, mortgage insurance does come with very real costs. But you aren’t given the convenience of simply writing one large check annually and calling it a day. Rather mortgage insurance premiums are paid as part of your total monthly mortgage payment, including:

• Principal payment towards down the loan balance.
• Interest charges for the applicable period.
• Property taxes.
• Hazard/homeowners insurance protecting physical property.
• Mortgage insurance premium payment passed through to the applicable insurance company.

In order to cover that monthly cost obligation, mortgage insurance premiums are paid through one of two primary avenues: 

1. Escrow Impound Account – The most popular option where the servicer pays your insurance as they collect premium amounts monthly tacked onto total mortgage payment.

2. Direct Bill – Your loan servicer bills you separately just for the mortgage insurance premium owed each month outside the normal mortgage payment process. Far less common route.

So as not to run into issues with potential missed payments or coverage lapses, most borrowers elect to have monthly premium funds escrowed then disbursed to insurance companies when due through that total monthly payment to their loan servicer.  

How to Get Rid of Mortgage Insurance

Nobody dreams of shelling out hundreds per month for decades just to protect their lender against potential losses on a mortgage. That’s where strategies around canceling and eliminating mortgage insurance premium obligations come into play. But what are your options exactly for ditching this annoying cost center?

Private Mortgage Insurance (PMI) Cancellation Options

Principal Pay Down

Reach 20 percent equity threshold through extra payments or appreciation

Request Removal – Specific conditions and timetables apply per type of loan. For example cancellation may be requested after:

• Reaching 22 percent equity with good payment history on a 30-year mortgage.
• Hitting 20 percent equity on a 15-year mortgage.
• Farm Home Administration borrowers follow different guidelines.

FHA Mortgage Insurance Premium Cancellation Routes

• Principal Pay Down – Get to 78 percent loan-to-value ratio based on original value to cancel annual premiums.
• Refinance – Shift to a conventional loan hitting 20 percent equity mark.
• Streamline Refi – Special program offering discounted refinancing of existing FHA loan potentially at lower rates.

Strategic navigation and tracking of mortgage insurance cancellation requirements can liberate housing budgets from hundreds in unnecessary costs each month. Consult lending specialists for guidance regarding individual loans.

Shedding expensive mortgage insurance premium obligations remains a top priority for most buyers required to initially put this financing expense in place. Carefully plotting the roadmap to cancellation can lead to thousands in savings over a housing tenure.

Frequently Asked Questions