Mortgage insurance was created to protect lenders during the Great Depression. In 1934, as foreclosures and loan defaults ran rampant, President Franklin D. Roosevelt signed the National Housing Act, marking the beginning of mortgage insurance premiums (MIP).
It wasn't until the 1950s that a real estate attorney from Milwaukee, Max H. Karl, developed private mortgage insurance (PMI) after growing tired of the strenuous paperwork that went along with the required MIP attached to a government loan.
Fast-forward to 2021 — borrowers are still struggling to determine if a home loan with mortgage insurance is right for them.
What is PMI?
Mortgage insurance, also known as private mortgage insurance (PMI), is a protection policy for the home loan lender or titleholder of a house. If the borrower defaults on their payments, the policy fulfills the borrower’s obligation to the loan terms. Borrower-paid mortgage insurance (BPMI) is the most common type of PMI. BPMI requires an additional monthly fee along with your regular mortgage payment.
Single-premium mortgage insurance (SPMI), which is less common, requires you to pay for the policy all upfront. With lender-paid mortgage insurance (LPMI), the lender pays the premium in exchange for a higher interest rate. Split-premium mortgage insurance, which is a hybrid of BPMI and SPMI, is the least common type.
How does mortgage insurance work?
Mortgage insurance policies protect lenders from losing money through foreclosures and defaults. Policies are issued to banks and other financial institutions in the United States. In most cases, lenders require it when financing a client who is considered somewhat “risky.”
Private mortgage insurance (PMI) is calculated based on your interest rate, loan-to-value (LTV) ratio, loan term, credit score and other risk factors. This amount is added to the overall expenses that make up your mortgage payments, or PITI (Principal, Interest, Taxes and Insurance).
Payments are due in monthly installments, usually until the borrower has gained 20% or more equity. PMI could also fall off once the balance of your loan hits 78% loan-to-value based on the original appraisal or if the borrower is halfway through the life of their loan. Lenders recalculate premiums annually, so you might see your costs go down each year as you continue to pay off the loan.
Mortgage insurance requirements by loan type
Depending on your lender and loan type, premiums are paid in a lump sum upfront at the closing table as a one-time payment, or you might make recurring payments, either annually or broken up into monthly payments.
MIP = Mortgage Insurance Premiums
PMI = Private Mortgage Insurance
- Conventional private mortgage insurance (PMI): Conventional loans require private mortgage insurance for buyers who can't afford or choose not to make a 20% down payment. Unlike other types of mortgages, a conventional loan is not guaranteed by the government. Private lenders offer both conforming and nonconforming (jumbo) loans.
- FHA mortgage insurance premium (MIP): All home loans backed by the Federal Housing Administration require mortgage insurance premiums (MIP). These loans have more lenient requirements for borrowers than conventional mortgages. An FHA loan requires either an upfront mortgage insurance premium (UFMIP) paid at the closing table, or you can roll it into the loan in monthly installments. The loan term and loan-to-value ratio are contributing factors that determine the amount of MIP the borrower pays. Check out the U.S. Department of Housing and Urban Development’s FHA mortgage insurance premium chart for more information.
- USDA guarantee fee: USDA loans provide and guarantee home loans to eligible borrowers in rural areas. This financing comes with lender insurance in the form of an upfront guarantee fee that’s paid once at the closing table. There is also a 0.35% fee paid annually or divided into monthly installments, depending on your lender.
- VA funding fee: VA loans do not require insurance but do require a funding fee. VA funding fees range from 1.4% to 3.6% of the total loan amount. For more information, read about what to look for to find the best VA loan lender.
What does mortgage insurance cover?
Mortgage insurance covers the borrower’s contractual obligations of a home loan. Policies cover a certain percentage of the loss if a borrower forecloses on their home. In other words, it protects the lender in case the borrower is unable to pay back the loan.
Mortgage insurance protects the lender, not the borrower. Borrowers need to be aware that it’s not the other way around. For example, it does not cover the borrower if their house is destroyed by a disaster — that’s what homeowners insurance is for.
For example, imagine you lose your job and can’t make your payments. You default on your loan with a remaining balance of $250,000. At foreclosure, the lender chooses to auction off the home at a lower price of $200,000. The insurance company covers the $50,000 difference, fulfilling the original terms of your loan.
How much is mortgage insurance?
The cost of PMI is typically 0.5% to 1% of the total loan amount annually. Mortgage insurance costs are either rolled into the loan and included in the monthly payment, paid upfront at the closing table or some combination of both.
The ongoing costs that you will have to pay each month can be anywhere from .45% to 1.05% of the loan, depending on the LTV ratio and length of your loan. Divide that number by 12 to project your monthly costs.
For example, imagine you borrow $250,000 on a 30-year fixed-rate term. If you bring a 4% down payment ($10,000) to the closing table, your upfront MIP would be 1.75%, or $4,375. If your recurring MIP is 0.85%, you will owe an additional $177.08 each month.
Mortgage insurance FAQ
- Is mortgage insurance required?
- Sometimes. Mortgage insurance is typically required on FHA loans or when borrowers bring less than 20% of a down payment to the closing table for conventional loans.
- How can I avoid PMI without 20% down?
- One way to avoid paying PMI without putting 20% down is finding a servicer that will lend you a piggyback loan, where a home equity loan or second mortgage is taken out at the same time as a first. The nickname is an 80/20 loan because, typically, the first mortgage is 80% LTV and the second mortgage or home equity loan is around 20% of the loan. Keep in mind that second liens almost always have higher interest rates than first liens because they are riskier. This could end up being a wash if you are trying to avoid a higher monthly payment from PMI in the first place.
You could also get the lender to pay for it through something called lender-paid mortgage insurance (LPMI). However, this also tends to come with higher interest rates and could be a wash, especially for someone with a lower credit score.
Lenders sometimes offer programs that require a low down payment and exclude PMI. It’s worth asking a lender if you’re eligible for any of these loans. If you’re a veteran, seeking a VA loan is a way to avoid paying mortgage insurance.
- How long do you have to pay mortgage insurance?
- For FHA loans, MIP lasts for 11 years or the life of the loan, depending on when you took your mortgage out. For PMI, you can request the servicer cancel it when your loan balance reaches 80% of the original home value. The servicer must automatically cancel PMI once the loan balance falls to 78% of the original home value. It must also cancel PMI once you’re halfway through your loan term.
- Does PMI decrease over time?
- Yes, a borrower's yearly premiums get recalculated on an annual basis based on the size of your loan. As the principal balance decreases, so does PMI.
- What is the difference between PMI and mortgage protection insurance?
- Private mortgage insurance (PMI) is protection for the lender. Mortgage protection insurance is protection for the borrower and is not required. This type of insurance can help pay off your mortgage if you die or are unable to work. The terms and limitations depend on the company and plan the borrower chooses.
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