Mortgage insurance is often required when borrowing money to buy a home, but not always understood. You may have many questions about what mortgage insurance is and how it works. Read on to discover what mortgage insurance is and what it may mean to you.
Mortgage Insurance Defined
Mortgage insurance or private mortgage insurance (PMI) is insurance for the mortgage provider, not the borrower, though it’s the borrower’s financial responsibility. The type of mortgage insurance needed is dependent on the type of loan.
When a loan is deemed risky, a bank may require mortgage insurance. The most common case in which PMI is required for a conventional loan is when a borrower gives a down payment of less than 20 percent at closing. However, there are other circumstances that may warrant mortgage insurance as well. The mortgage insurance protects the lender if the borrower defaults on the loan.
Which Loan Types Need It?
A few types of loans require mortgage insurance. Conventional loans typically require PMI if you put down less than 20%. Conventional loans aren’t alone in this requirement. FHA loans also require mortgage insurance. FHA loans require an upfront mortgage insurance premium (UFMIP), and then an annual premium (MIP). While there are other loan types, they do not require mortgage insurance.
For instance, VA loans don’t require mortgage insurance, but they do require a funding fee. This fee is similar to the upfront premium for FHA loans. USDA rural home loans don’t require private mortgage insurance but do require an upfront premium if buyers put down less than 20% of the total loan. The USDA even lets buyers finance this premium as part of their loan.
How Much Does It Cost?
The cost will depend on how much you put down, so, if you put 15% down, you’ll pay less than if you put 5% down. This is because PMI is calculated based on the total loan value. Specifically, it’s calculated based on the how much you owe versus the value of the house, also known as loan to value ratio. How much you’ll pay will depend on how much you put down and how high your credit score is.
According to Investopedia, PMI for a conventional loan generally runs about 0.5% to 1% of the total loan value per year. For example, if you have a $300,000 loan, you may pay $3,000 a year, which translates into $250 a month.
For an FHA loan, the upfront premium (UFMIP) is 1.75% of the total loan cost. Then the monthly premium is a calculated percentage based on the loan to value ratio. The loan value is multiplied by the annual MIP rate. This would be divided by 12 to get the monthly payment.
Paying the Premium
Upfront premiums for FHA loans can be paid in lump sum at closing, but they’re usually paid in installments. For your annual premium, you have the choice of paying it in a lump sum or paying on a monthly basis throughout the year. When and how you pay will depend on the specific terms of your loan.
For conventional loans, the borrowers can cancel their PMI once they’ve reached 20% equity in their home. There are specific laws that pertain to when and how this can be removed from the loan. However, with FHA loans, the mortgage insurance must be kept for the entire life of the loan.
If you have questions about mortgages or mortgage insurance, A and N Mortgage can help. Now that you have a better understanding of mortgage insurance, get an online mortgage pre approval and start searching for a new home today!