Mortgage Insurance: What Is It and Does Your Borrower Need It?

Mortgage insurance makes homeownership possible even when you don’t have a large down payment saved. When you pay a mortgage insurance premium monthly, you can borrow money for a mortgage with less than the traditional 20% down payment. 

The two most common types of insurance required are Private Mortgage Insurance and FHA mortgage insurance.  

What is Mortgage Insurance? 

Mortgage insurance, whether PMI or MIP, is an insurance policy that creates a safety net for the lender. You pay the premiums on the policy monthly as a part of your mortgage payment, ensuring the lender’s security. 

Because lenders focus on your risk of default, having mortgage insurance decreases the risk and increases your chances of approval. The type of loan you apply for determines the type of mortgage insurance you pay, either PMI or MIP. 

How Does PMI Work? 

PMI stands for Private Mortgage Insurance. You pay this premium if you borrow a conventional loan or a non-government-backed loan and put down less than 20% on the house. The policy protects the lender if you stop making payments, paying them back a percentage of the amount lost after foreclosing on the home. 

The Types of PMI 

When it comes to paying PMI, you can choose the plan that suits your financial abilities. Most lenders offer various options, including: 

Borrower-Paid PMI 

You pay PMI premiums monthly based on the annual premium divided by twelve. The lender adds the amount to your required mortgage payment and applies the applicable amount to the mortgage insurance each month. 

The lender continues charging the premiums until you have 22% equity in the home (owe 78% of the home’s original value). When you reach a 78% LTV, the lender must cancel your PMI, which lowers your monthly payment for the rest of the term. 

You can also request cancelation when you have 20% equity. Lenders aren’t legally required to cancel PMI at an 80% LTV. To cancel, you must prove you qualify by having a timely payment history, no additional liens on the property, and sometimes a new appraisal proving the property’s value. 

Lender-Paid PMI 

If you don’t like the idea of a higher mortgage payment, you can request that the lender cover the PMI premium. However, understand that it’s usually in exchange for a higher interest rate. The lender then pays the premium in one lump sum, and you don’t have to worry about paying PMI.  

Before choosing this option, compare the total cost of the higher interest rate versus paying PMI based on how long you intend to stay in the home.  

Single-Premium Mortgage Insurance 

You also have the option to pay the mortgage insurance premium upfront. This means you pay it at the closing. Only choose this option if you plan to stay in the house long-term and don’t foresee refinancing in the near future. Single-premium PMI is not refundable, so if you sell the house or refinance before hitting 22% equity, you won’t receive a refund of the remaining premium paid. 

How Does MIP Work? 

MIP stands for mortgage insurance premium and refers to the insurance required on all FHA loans regardless of the down payment. The difference between MIP and PMI is you pay MIP for the life of the loan; you don’t have the option to cancel the insurance when you have 20% – 22% equity in the home. 

The Types of MIP Insurance 

There are two types of MIP insurance all borrowers pay: 

• Upfront mortgage insurance: Borrowers pay an upfront MIP premium of 1.75% of the loan amount or $1,750 for every $100,000 borrowed. You can pay it at the closing as a part of your closing costs or wrap it into the loan amount. 
• Annual mortgage insurance: The annual mortgage insurance amount depends on how much you borrow, how long you borrow funds, and the amount of your down payment. It ranges from 0.15% to 0.75%. 

The Pros and Cons of Mortgage Insurance 

There are pros and cons when deciding whether to borrow a mortgage with mortgage insurance premiums. 

Pros 

• Requires a lower down payment, making homeownership more accessible 
• Allows you to keep more of your savings to cover emergencies, home repairs, or other expenses 
• You can request PMI removal when you owe less than 80% of the home’s value 

Cons 

• Mortgage insurance increases your monthly payment 
• The insurance policy protects the lender, not you 
• You must refinance the loan to remove FHA MIP 

Final Thoughts 

Mortgage insurance can be the key to unlocking your homeownership dreams. It’s a policy that protects lenders and makes loans more accessible for borrowers. Whether it helps you own a home sooner or keep more money in your pocket, PMI or MIP is a tool that evens the playing field, helping you achieve your homeownership dreams. Click here to learn more about all the different loan options.