Mortgage Insurance 101
Own Up Staff
Own Up Staff
Own Up is a privately held, Boston-based fintech startup that is on a mission to make sure every home buyer receives a fair deal on their mortgage by unconditionally empowering individuals with customized data, personalized advice, and unprecedented access to mortgage lenders to create better financial outcomes and simplify the home financing experience.
What is mortgage insurance?
Mortgage insurance reimburses the lender if borrowers default on their loan. Mortgage insurance requirements vary based on the loan type, but typically is charged to borrowers who put down less than a 20% down payment on a home. A 20% down payment translates into an 80% loan-to-value ratio, or LTV. When that ratio is higher than 80%, mortgage insurance is often required.
About Private Mortgage Insurance (PMI)
PMI is required for conventional loans with less than a 20% down payment (unless a second loan is secured to reach the 20% threshold). A conventional loan is any type of home loan that is not offered or secured by a government entity, like the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA). Conventional loans are available through or guaranteed by a private lender or the two government-sponsored enterprises (Fannie Mae and Freddie Mac).
PMI is based on the loan size, with lower rates for higher down payments. PMI is generally between $30 and $70 a month for every $100,000 of the loan amount.
Mortgage insurance for government-backed loans
FHA mortgage insurance is called mortgage insurance premium, or MIP. The FHA charges an upfront premium of about 1.75% of the loan amount (that can be added into the loan balance) and an annual premium of 0.45% to 1.05% of the loan cost that is divided by 12 and part of the monthly mortgage payment.. The exact amount is based on the size of the loan, the LTV, and the loan term.
Home Ready (Freddie Mac) and Home Possible (Fannie Mae) are loan programs specifically for low- to moderate income borrowers and require mortgage insurance for those who put down less than 20%, with reduced mortgage insurance rates for borrowers with put down at least 10%.
USDA home loans are for people buying in designated rural areas. It calls mortgage insurance a “guarantee fee” and costs up to 3.5% of the loan and an annual fee of 0.5% divided among monthly payments.
Which types of mortgage insurance can be cancelled?
Home Ready and Home Possible loans. Yes. Once the borrower equity reaches 20% and certain criteria are met.
Conventional loans. Yes. Once borrower equity reaches 20% they can refinance into a new loan without PMI. PMI is automatically cancelled once borrower equity reaches 22%.
USDA home loans. No. The 0.5% annual fee stands for the life of the loan
FHA loans. Usually not. Mortgage insurance can be cancelled for loans closed after December 31, 2000 and assigned a case number before June 3, 2013 that meet eligibility requirements. For loans closed after June 3, 2013, mortgage insurance is only terminated when the mortgage is paid off in full.
How do you cancel PMI?
Wait for It to End. If you are current on your mortgage payments, PMI will automatically terminate when your principal balance is 78 percent of the original home value, which means you have 22 percent equity in your house.
Make Additional Payments. On a 30-year mortgage with 10% down, you will cross the 80% loan-to-value threshold in about seven years if you make the minimum monthly payments. Any extra payments you make over that time will accelerate that timeline.
Get a Home Appraisal. A home appraisal determines your home’s current market value. The combination of your increased equity in the house over time and its change in market value could lead to a lower loan-to-value ratio.
Refinance Your Mortgage. If mortgage rates have dropped since you bought your house, refinancing might result in a lower LTV. But first do your math, as refinancing has costs that need to be factored into any decision. If you can drop your interest rate at least 1 percentage point, refinancing is worth considering.
Instances where mortgage insurance is not required with less than 20% down
- Active and retired veterans can access VA home loans, which have no mortgage insurance. Instead some lenders must pay a one-time funding fee that is less than 3.6% of the loan amount (the exact amount varies).
- Borrowers can take out a second mortgage to reach the 20% threshold. This could be a fixed-rate loan or a home equity line of credit (HELOC). The deciding factor in whether to consider this option is how quickly you expect your home to appreciate. With rapid home appreciation, you would reach the 78% threshold sooner and start saving, making HELOC less advantageous.
How common is PMI?
Between 2013 and 2019, the percent of loans with PMI has increased from 30.2% of all conventional loans to 36.3% of all conventional loans.
In 2019, 13% of all buyers financed 100% of the loan amount according to data from the National Association of Realtors. For buyers ages 22 to 29, 64% financed over 90% of the loan amount, requiring PMI or another type of mortgage insurance with most lenders.
Should you wait to buy until you can avoid mortgage insurance?
Everyone’s individual financial situation is different, but here are four things to consider.
- Your credit score. For borrowers with good credit scores, the scales tip toward taking the PMI plunge, as they are offered lower mortgage interest rates.
- Mortgage interest rates. As of June, 2020, mortgage insurance rates are near all-time lows: Even if you only have enough money for 10% down, paying mortgage insurance could be a savings. A 0.5% change in your mortgage interest rate could save you tens of thousands of dollars over the life of a loan. Calculate the amount you would pay for mortgage insurance. It may be that paying mortgage interest is better than waiting a year or two, when mortgage rates could go up. Conversely, when interest rates are high, it can be worth waiting.
- Your rent. If your rent payments are high and would be similar to your mortgage including mortgage insurance payments, a mortgage is a better financial choice for many people, provided you can make the needed down payment. Monthly mortgage payments are often fixed. Rents are not fixed—and usually go up. If a mortgage would be more than your rent with PMI, consider whether it’s worth it.
- Home prices. If you live in an area where home prices are on the rise, paying mortgage insurance may make better financial sense than waiting a year when home prices could be higher. If home prices might get lower in the future, you might consider waiting.