Many loans today require mortgage insurance including conventional, FHA, and USDA loans. You can only avoid mortgage insurance if you put down at least 20% on a conventional loan. All FHA and USDA loans carry mortgage insurance regardless of the amount of your down payment. Knowing how it works and what to expect can help you prepare for a mortgage.
What is Mortgage Insurance?
If you have to pay mortgage insurance, know that it’s coverage for the lender, not you. You pay the premiums, but the protection covers the lender should you stop making your payments. Government-backed loans require the insurance in order for the FHA and USDA to guarantee the loan. The FHA and USDA don’t write or fund loans – instead, they guarantee them for the lender. This is how lenders are able to give loans with flexible guidelines, like credit scores as low as 580 or debt ratios as high as 41%.
Conventional loans require PMI or Private Mortgage Insurance if you put less than 20% down on the home. Without 20% down, you pose a higher risk of default. In order for lenders to write the loan, they want the protection of Private Mortgage Insurance. If you stop making payments, the lender will receive reimbursement from the insurance company.
How Government-Backed Mortgage Insurance Works
If you use FHA or USDA financing, you actually pay mortgage insurance twice. The first time is at the closing. You’ll see it called the upfront funding fee or upfront mortgage insurance. This money goes straight to the FHA or USDA. The FHA charges 1.75% of the loan amount upfront and the USDA charges 1% of the loan amount. You can pay the fee in cash at the closing or wrap it into your loan amount.
The FHA and USDA also charge annual mortgage insurance. The name is deceiving, though, since you pay it monthly. The lender pays the premium to the insurance company on your behalf once a year, but you pay 1/12th of the premium each month with your mortgage payment.
Government-backed mortgage insurance lasts for the duration of the loan. If you take out a 30-year loan and you keep the loan for the entire term, you pay mortgage insurance the entire time. The only thing that differs is the amount of the premium that you pay. FHA loans, for example, charge 0.85% of the outstanding premium each year. The lender calculates your premium based on your average outstanding balance each year, as you pay the balance mortgage balance down, your premium decreases.
How Conventional Loan Mortgage Insurance Works
Conventional loans have Private Mortgage Insurance because they aren’t backed by a government entity. The PMI comes from several different companies – each lender typically has a company they prefer to use. Each insurance company has different pricing too.
You only pay PMI if you put less than 20% down on a home, though. The amount you pay remains the same for the term you must carry it. This is where PMI differs from government-backed mortgage insurance, though. You only pay PMI until you owe less than 80% of the home’s original value. You can determine when this will occur by looking at your PMI Disclosure or amortization table.
Once you owe less than 80% of the home’s value, you can request PMI cancelation in writing. The lender will evaluate your situation and decide at that point if you qualify to cancel the insurance. Lenders look at:
- Your payment history – Do you make your payments on time?
- Your current housing history – Are you current on your payments?
- The home’s current value – Did the home’s price remain stable or appreciate?
If you make your payments on time and are current on your payments, most lenders will allow cancellation of your PMI.
If you don’t cancel the PMI once you hit the 80% point, the lender must cancel it once you owe less than 78% of the home’s original value – it’s the law.
The lender reserves the right to not cancel the insurance if your home’s value decreased or you are behind on your payments. Remember, the insurance protects the lender should you default on your loan. They take a big risk when letting the insurance go.
Getting Rid of Mortgage Insurance
Whether you have a government-backed loan or a conventional loan, there’s one way to get rid of mortgage insurance once and for all – refinance. Of course, you need all of the right pieces to fall into place.
If you have a government-backed loan and you owe less than 80% of the home’s value, you can refinance into a conventional loan. If you have a conventional loan, but have paid the balance down significantly or the home appreciated a lot, you may refinance the loan, order a new appraisal and get rid of the PMI.
Mortgage insurance seems like a nuisance, but it helps you get the financing you need. With an insurance policy in place, lenders are more likely to give you the financing you need, even if you have a high LTV or even a low credit score.