What is mortgage insurance and how does it work?
Mortgage insurance lowers the risk to the lender of making a loan to you, so you can qualify for a loan with a lower down payment.
When home lending first began many years ago, the banks all required a substantial down payment. As this changed over the years, they realized that the lower down payment loans were putting them at higher risk. There is a greater likelihood of people not making their payments in tough times if they have less equity.
With a down payment of less than 20 percent of the purchase price on a Conventional loan, you will be required to obtain and pay for mortgage insurance. Mortgage insurance is also typically required on FHA and USDA loans. This type of insurance is designed to protect the lender not the borrower. It lowers the risk to the lender of making a low down payment loan that you might not otherwise be able to manage.
There are a variety of types of MI. Most common is the monthly MI that is included in with your payment. There is also what is known as Lender Paid MI where it is built in to the rate. And there are other options as well. Some borrowers are looking for the lowest monthly payment. Some are looking for the lowest cost over the first few years. We can certainly discuss all of the options and see which is best for you. Mortgage insurance, no matter what kind, protects the lender– in the event a borrower defaults on payments.
There are several different kinds of loans available to borrowers with low down payments. Depending on what kind of loan you get, you will pay for mortgage insurance in different ways:
With a conventional loan, your lender will arrange for mortgage insurance with a private company. Private mortgage insurance (PMI) rates vary by down payment amount, program type and credit score but are generally cheaper than FHA rates for borrowers with good credit. Most private mortgage insurance is paid monthly, with little or no initial payment required at closing. Under certain circumstances, you can cancel your PMI later when you reach at least a 20% equity position.
With a Federal Housing Administration (FHA) loan, your mortgage insurance premiums are paid to the Federal Housing Administration (FHA). FHA mortgage insurance is required for all FHA loans. It costs the same no matter your credit score, with only a slight increase in price for down payments less than five percent. FHA mortgage insurance includes both an upfront cost, which can be financed, and a monthly cost, included in your monthly payment.
With a US Department of Agriculture (USDA) loan, the program is similar to the Federal Housing Administration, but typically cheaper. You will pay for the insurance both at closing and as part of your monthly payment. As with FHA loans, you can roll the upfront portion of the insurance premium into your mortgage instead of paying it out of pocket.
With a Department of Veterans’ Affairs (VA)-backed loan, the VA guarantee replaces mortgage insurance, and functions similarly. With VA-backed loans, which are loans intended to help service members, veterans, and their families, there is no monthly mortgage insurance premium. However, you will pay an upfront “funding fee.” This can be financed and generally is to reduce the cash needed at closing. The amount of that fee varies based on:
- Your type of military service
- Your down payment amount
- Your disability status
- Whether you’re buying a home or refinancing
- Whether this is your first VA loan, or you’ve had a VA loan before
As an alternative to mortgage insurance, some lenders offer what is known as a “piggyback” second mortgage. This option may be marketed as being cheaper for the borrower, but that doesn’t necessarily mean it is. Always compare the total cost before making a final decision. We can discuss all of your options to determine what is bet for your needs.