what is mortgage insurance

What is Mortgage Insurance and When do you Pay It?

If you’re shopping for a mortgage, you’ve likely heard the term mortgage insurance. You’re wondering if you have to pay it and how much it will add to your mortgage payment. 

The good news is not everyone pays mortgage insurance, but even if you must pay it, MI helps you get approved for a mortgage. Here’s everything you must know.

What is Mortgage Insurance?

Mortgage insurance is coverage for the lender, even though you pay it. The insurance protects the lender if you default on your loan. The insurance company charges an annual premium to the lender and the lender breaks up the payments into 12 equal installments adding them to your mortgage payment.

Who Pays Mortgage Insurance?

You pay mortgage insurance on several types of loans including:

  • Conventional loans – If you put down less than 20% on a conventional loan, you’ll pay Private Mortgage Insurance. The amount you pay depends on your loan-to-value ratio and credit score. PMI only lasts until you owe less than 80% of the home’s value, at which point the lender cancels it. If you pay the balance down faster or improve the home’s value, you can cancel it sooner.
  • Government-backed loans – FHA and USDA loans require mortgage insurance too. It doesn’t matter how much money you put down; you’ll pay mortgage insurance for the life of the loan. While it seems like an extra expense, government-backed loans have more flexible guidelines, allowing you to secure financing when you wouldn’t be able to get a conventional loan. 

How Does FHA and USDA Mortgage Insurance Work?

FHA and USDA loans charge two types of mortgage insurance – upfront and annual mortgage insurance. The upfront mortgage insurance is a percentage of your loan amount. FHA loans charge 0.85% of the loan amount and the USDA charges 1.0% of the loan amount. The upfront MIP is a part of your closing costs.

The annual mortgage insurance is based on your principal balance and decreases each year as you pay the balance down. While the mortgage insurance lasts for the life of the loan, the balance doesn’t remain the same – you’ll pay less and less each year as you near the end of the term.

If you want to get out of mortgage insurance in a government-backed loan, you must refinance it. Many people use the FHA or USDA loan to get into a home when they have less-than-perfect credit and a low down payment, but then refinance when they improve their credit and build equity in the home.

Bottom Line

Mortgage insurance isn’t as bad as it seems. It’s a way to help you secure financing whether you have good credit, but a low down payment and secure a conventional loan or you need more flexible financing options and secure a government-backed loan.

Mortgage insurance doesn’t add a lot to your mortgage payment, and it’s a way to ensure you get the financing you need to buy your dream home.

Written by the Mortgage Loan Center.