Mortgage insurance allows those with below average credit scores or who may not be able to provide a 20 percent down payment purchase a home. For specific government-insured or guaranteed loan programs, mortgage insurance may be required.
How does mortgage insurance work?
Mortgage insurance helps provide a level of protection for the lender. The insurance protects the lender, not the borrower, in a situation where the buyer defaults on their mortgage and the home ends up going into foreclosure. It also helps protect the lender against losses if you stop making your payments.
Mortgages that are insured make up a large portion of the mortgage market and can have a significant impact on a buyer’s purchasing power. Insuring your mortgage lowers the risk for the lender when providing you with a loan and helps you qualify for a loan that you might not have been able to get without being insured. Your premium and coverage of mortgage insurance will depend on the amount borrowed.
They may sound similar, but don’t confuse mortgage insurance with homeowners insurance. The difference between the two is that mortgage insurance protects the lender from the risk of default or foreclosure on the loan, whereas homeowners insurance protects you from potential damage to your home.
When do you need mortgage insurance
There are some situations where mortgage insurance is most often required. Insuring your mortgage is typically required if the loan-to-value (LTV) ratio is greater than 80 percent. In other words, this is when the lender is lending you more than 80 percent of the property’s value. For example, if you’re buying a home appraised at $300,000 and your loan amount is $250,000, your LTV ratio equals 83.3 percent.
Curious if your mortgage will need Mortgage Insurance? Start by figuring out if you can put 20 percent down or more. If you can answer yes to this question, you most likely won’t be required to have mortgage insurance. If the answer is no, you’ll most likely need it.
What types of mortgage insurance are available?
Conventional or government-backed loans may require mortgage insurance. Some examples include:
- Private mortgage insurance (PMI): PMI covers conventional loans and is the most common. Conventional loans are not insured by a federal agency. This type of mortgage insurance can be added to your monthly mortgage payment. A lower down payment may be required at the time of closing. Typically, PMI will be required with a down payment of less than 20 percent.
- FHA MIP: Mortgage insurance premium (MIP) is applied to Federal Housing Administration (FHA) insured loans. These loans are financed through the government and require mortgage insurance. You’ll most likely pay mortgage insurance for the duration of your loan term, along with paying an upfront MIP.
- USDA Annual Fee: The United States Department of Agriculture (USDA) charges an annual fee for your USDA guaranteed loan. This is for buyers who purchase a home in rural areas and don’t require private mortgage insurance regardless of your down payment amount. An upfront fee and annual fee will be required.
- VA Funding Fee: A one-time upfront funding fee is applied to Veterans Administration (VA) guaranteed loans. If you’re using a VA home loan to buy, build, improve, or repair a home or to refinance a mortgage, you’ll need to pay the VA funding fee unless you meet certain requirements. VA loans do not charge a monthly MI payment.
What are the pros of mortgage insurance?
There are many positives when it comes to insuring your mortgage. Some of the pros are:
- Allows you to purchase with a smaller down payment: Mortgage insurance gives homebuyers the chance to enter the marketplace even if they have limited resources. This is common among first-time homebuyers who may not have the most in their savings.
- Can get you a home sooner: Mortgage insurance helps those who don’t have a minimum of 20 percent for a down payment buy their dream house that much sooner.
- Helps consumers afford a home that is more expensive: Mortgage insurance can help homebuyers qualify for a bigger mortgage, helping the buyer purchase a more expensive home.
- PMI can be canceled (PDF): If you have PMI, you may be able to cancel it after you make enough payments on your loan to reach more than 22 percent equity in your home.
- Mortgage insurance may be tax-deductible: PMI, along with other eligible forms of mortgage insurance premiums, may be tax-deductible if the deductions are itemized. Please consult with your personal tax advisor for more information.
What are the cons of mortgage insurance?
There are a few cons that come along with mortgage insurance, which include:
- Can be costly: If you put down a low down payment, you may end up paying more for your mortgage insurance.
- It could take years to pay the mortgage insurance: It may be a convenient option now, but paying the insurance until your total home equity reaches 22 percent can become a time-consuming investment.
- May not be easy to cancel: While private mortgage insurance may not be as difficult to cancel, there are more specific guidelines when it comes to FHA Mortgage Insurance Premiums and USDA Annual Fees. Whether or not you’re able to cancel FHA MIP’s is dependent on when your loan was originated and your case number assignment date. USDA annual fees may not be canceled.
- It’s not tax deductible for all homeowners: Even though mortgage insurance could be deducted as an itemized deduction on your tax return, this is only applicable if certain requirements are met. Make sure to consult with your personal tax advisor.
Mortgage insurance can help millions of people become homeowners and can increase the ability to obtain a mortgage in an affordable way. Now that we’ve answered the question “what is an insured mortgage?” you can move forward making a sound decision when it comes to buying your home. Mortgage insurance comes with both advantages and disadvantages, so it’s important to do your research. If you’re still on the fence about whether you need to insure your mortgage, talk with a Home Lending Advisor to discuss your options.