Saving 20% for your down payment on a house can be tough, but many lenders will work with you on a smaller down payment. Lenders can take this risk because mortgage insurance offers financial protection if you — the borrower — stop making payments.
How Does Mortgage Insurance Work?
Mortgage insurance is a type of insurance that protects lenders in case a borrower defaults on their mortgage payments. It is typically required for borrowers who have a down payment of less than 20% of the home's purchase price. When a borrower obtains a mortgage loan with less than a 20% down payment, the lender may view them as a higher risk. To mitigate this risk, the lender requires the borrower to purchase mortgage insurance. This insurance provides financial protection to the lender if the borrower fails to make their mortgage payments.
The cost of mortgage insurance is typically added to the borrower's monthly mortgage payments. The specific amount depends on factors such as the loan amount, loan-to-value ratio, and the borrower's credit score. The insurance premium is calculated as a percentage of the loan amount and is paid by the borrower. In most cases, mortgage insurance remains in effect until the borrower has paid off a certain percentage of the loan, usually when the loan-to-value ratio reaches 80%. At this point, the borrower may request the cancellation of the mortgage insurance. However, if the borrower has a government-backed loan, such as an FHA loan, the mortgage insurance may be required for the life of the loan.
It's important to note that mortgage insurance protects the lender, not the borrower. It allows lenders to offer mortgage loans to borrowers with a smaller down payment, but it does not provide any financial benefits or protection to the borrower.
Which Home Loans Require Mortgage Insurance?
| Is mortgage Insurance required? | How is it paid? | Can it be removed? | |
|---|---|---|---|
| Conventional mortgages | Yes, with a down payment less than 20% | Typically paid monthly | Yes, when you reach 80% equity in your home |
| FHA loans | Yes | Paid upfront and monthly | It depends. With down payment of 10% or more, mortgage insurance can be removed after 11 years. Otherwise, it typically lasts for the term of your mortgage. |
| USDA loans | Yes | Upfront and monthly | No |
| VA loans | No | N/A | N/A |
Types of Mortgage Insurance
Understanding the types of mortgage insurance can help you not only choose the right insurance for your situation but will help you get the best rates. Here are the types of mortgage insurance and how they work.
Private Mortgage Insurance (PMI)
Private mortgage insurance (PMI) may be required if you decide a conventional loan is the best mortgage for you and your down payment is less than 20%. Your lender will make arrangements with a private insurance company and pass the premium on to you.
Your monthly mortgage payment typically includes your PMI premiums. Your lender puts the PMI portion of your monthly payment into an escrow account. An escrow account is a third-party account that holds money to be sent to other parties. Your escrow account may hold funds for property taxes, homeowners insurance and PMI.
What does that look like when you actually get a mortgage? Let’s say you buy a home for $150,000, and you made a 15% down payment of $22,500. Since it’s less than 20%, your lender requires you to pay for PMI. Your monthly home loan payment is $648.
Let’s say your PMI is 1% of the principal amount of the loan, and your loan amount is $127,500. This means your PMI is $1,275 per year or $106.25 per month. This brings your monthly payment to $754.25, and that doesn’t include your taxes or homeowners insurance.
Mortgage Insurance Premium (MIP)
FHA loans are another option you might see when you get in-person or online mortgage quotes. FHA requires two types of mortgage insurance premiums (MIP). Your mortgage insurance premium is the amount you pay for mortgage insurance. FHA loans typically require:
- An upfront MIP: This is an amount you pay when you get an FHA mortgage. It’s 1.75% of your loan amount. Let’s say your FHA loan amount is $125,000. Your upfront MIP would be $2,187.50. You can pay it as a part of your closing costs or have it rolled into your mortgage.
- A monthly MIP: This is an amount you pay as a part of your monthly mortgage payment. It varies depending on the amount of your down payment, the amount of your loan and the term of your loan. It ranges from 0.045% of your loan amount per year to 1.05% of your loan amount per year.
Even with the MIP, low down payment and flexible credit score requirements make FHA loans a good option for a first-time home buyer. You can learn more about first time home buyer programs in our mortgage guide.
Single-Premium Mortgage Insurance (SPMI)
Single-premium mortgage insurance (SPMI) is a private mortgage insurance option. Instead of paying your PMI each month, you pay a lump sum when you close on your mortgage. The advantage to SPMI is a lower monthly payment since you’re not paying back your home loan and paying for mortgage insurance each month.
What are the disadvantages of SPMI? The main one is it can be tough to come up with another lump sum payment when you’re already trying to buy a house. But you may be able to get the seller or lender to cover SPMI.
SPMI costs vary and can range from about 0.5% to 6% or more depending on your down payment and other factors. For a $150,000 loan, your SPMI could range from $750 to $9,000. If you have the funds, SPMI is an option worth considering if your priority is the lowest monthly payment possible.
Borrower-Paid Mortgage Insurance (BPMI)
Borrower-paid mortgage insurance (BPMI) is the most common type of mortgage insurance. It means that the borrower pays the premium for mortgage insurance. This adds to your monthly payment, but in most cases, your mortgage insurance can be removed over time.
You can ask for your lender to remove your BPMI once your mortgage reaches 80% of the original value of your home. If you don’t ask to remove your BPMI, your lender must remove your mortgage insurance once your mortgage reaches 78% of the value of your home. Your lender also must end BPMI the month after you reach the midpoint of your payment schedule. For example, if you have a 30-year mortgage, your lender must remove your BPMI the month after you’ve paid for 15 years.
Lender-Paid Mortgage Insurance (LPMI)
Lender-paid mortgage insurance (LPMI) is when your lender pays for your mortgage insurance. While this sounds like a great deal — and it might be — lenders typically charge a higher interest rate for LPMI. But you may have a lower monthly payment with LPMI.
The main drawback to LPMI is that your lender can’t remove it from your mortgage. Once you accept LPMI and the higher interest rate, you have it for the life of your mortgage. If your priority is having the lowest monthly payment possible, look for a lender that offers LPMI.
Costs and Estimating Rates
How much will mortgage insurance cost? That depends on a few factors:
- Your down payment
- Your credit score
- Type of mortgage
- The term of your mortgage
A higher down payment and credit score typically result in a lower mortgage insurance premium.
If you’re getting a conventional loan, your lender will typically choose your mortgage insurance provider. If you want to get a sense of the cost, look for mortgage insurance rate cards.
These cards list the cost of your mortgage insurance as a percentage of your loan amount. The rates are based on your loan-to-value ratio (LTV). Your LTV is your loan balance compared to the value of your home. If you make a 10% down payment, you will have a 90% LTV when your mortgage starts.
Rate cards may also include different coverage amounts. This is the percentage of your home’s value that the insurance provider will pay your lender. It may also include different rates depending on your credit score, whether you have a fixed- or adjustable-rate mortgage and how long your mortgage will last.
The best way to know exactly how much your mortgage insurance will cost is by asking your lender for a quote. Lenders include PMI in your loan estimate and on your closing disclosure. If you’re not happy with the PMI option they choose, ask for other options. Some lenders allow you to choose between a monthly premium, an upfront premium or a combination of both. Others only have one option.
Do I Have to Pay for Mortgage Insurance?
The answer is it depends. If you qualify for a conventional mortgage but don’t have a 20% down payment, it might be the right move. An FHA loan might be a good fit too — even though FHA loans also have mortgage insurance. If you qualify, a VA loan might be an option because mortgage insurance isn’t required.
In some cases, your situation may dictate your mortgage options, and you don’t have much of a choice when it comes to paying for mortgage insurance. For example, self-employed borrowers sometimes have a more difficult time finding a mortgage.
If you’re not sure which route to take, talk to multiple lenders. Let them know how much you have saved for a down payment. Review each quote carefully and look at the mortgage insurance costs. Compare interest rates and origination fees. Look at how much your total monthly payment will be. Keep in mind the service you receive when you ask for a quote — it is likely the service you’ll receive for the life of your loan.
Mortgage insurance might feel like you’re paying something for nothing. But if you can’t bring a 20% down payment, mortgage insurance can be a great way to get into the home you want with a down payment you can afford.
Frequently Asked Questions
How do I get pre-approved?
First, you need to fill out an application and submit it to the lender of your choice. For the application you need 2 previous years of tax returns including your W-2’s, your pay stub for past month, 2 months worth of bank statements and the lender will run your credit report. Once the application is submitted and processed it takes anywhere from 2-7 days to be approved or denied. Check out our top lenders and lock in your rate today!
How much interest will I pay?
Interest that you’ll pay is based on the interest rate that you received at the time of loan origination, how much you borrowed and the term of the loan. If you borrow $208,800 at 3.62% then over the course of a 30-year loan you will pay $133,793.14 in interest, assuming you make the monthly payment of $951.65. For a purchase mortgage rate get a quote here. If you are looking to refinance you can get started quickly here.
How much should I save for a down payment?
Most lenders will recommend that you save at least 20% of the cost of the home for a down payment. It is wise to save at least 20% because the more you put down, the lower your monthly payment will be and ultimately you will save on interest costs as well. In the event that you are unable to save 20% there are several home buyer programs and assistance, especially for first time buyers. Check out the lenders that specialize in making the home buying experience a breeze.
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