Mortgage Insurance

What is Mortgage Insurance?

Typically, borrowers making a down payment of less than 20 percent of the purchase price of the home will need to pay for mortgage insurance. Mortgage insurance also is typically required on FHA, USDA and VA loans. VA loans require a different type of mortgage insurance called a VA Funding Fee, but is dependent on many factors including your service record. Mortgage insurance lowers the risk to the lender of making a loan to you, so you can qualify for a loan that you might not otherwise be able to get. But, it increases the cost of your loan. If you are required to pay mortgage insurance, it will be included in your total monthly payment that you make to your lender, your costs at closing, or both.

Conventional Mortgage Insurance (PMI)

Mortgage insurance is usually paid by the borrower and works to protect the lender. Your lender will likely attach a private mortgage insurance requirement if your down payment isn’t at least 20%. However, there are a variety of mortgage insurance types that can impact your monthly bill in different ways.

Type of Private Mortgage Insurance (PMI)

Mortgage insurance can come in many different forms and premiums can be paid off in a variety of ways. Here’s some of the most common mortgage insurance types and how they’ll impact what you pay month to month.

  • Borrower-Paid Mortgage Insurance
  • Lender-Paid Mortgage Insurance
  • Single Premium Mortgage Insurance
  • Split Premium Mortgage Insurance
Borrower-Paid Mortgage Insurance

The most common type of mortgage insurance is activated when the borrower can’t contribute at least 20% of the home’s purchase price for a down payment. Borrower-paid mortgage insurance, or BPMI, usually costs between 0.5-1% of the overall loan amount annually.

If you were to take out a $300,000 mortgage with a BPMI stipulation attached, you’d be paying $1,500-$3,000 in insurance premiums each year. This cost is broken down into 12 equal payments and tacked on to your monthly mortgage bill. You’d be required to make this payment until your ownership stake in the home meets or exceeds 20% of the purchase price.

According to industry experts, the process of gaining enough equity to shed the BPMI expense takes an average of 11 years of consistent amortization.

Some lenders may allow avenues that help you cancel BPMI sooner. If your home’s value appreciates after a few years, your stake in the property will increase as well, possibly above 20% of the original purchase price. Your mortgage holder may allow the BPMI requirement to be released if this increase in value can be proven.

Refinancing is another option that could help you get rid of BPMI early. However, the cost of refinancing can be steep, so you’ll have to weigh the costs verses potential savings and consider whether taking the step makes sound financial sense.

Lender-Paid Mortgage Insurance

Lender-paid mortgage insurance, or LPMI, might sound like the cost is completely carried by your mortgage provider, but as the borrower you’ll end up covering this expense as well.

While creditors do pay for lender-paid mortgage insurance coverage upfront, the cost of these premiums are worked into your monthly mortgage payment in the form of a slightly increased interest rate.

Since this cost is built into the loan structure, LPMI can’t be canceled when you reach 20% equity in the home. The only way to lose the LPMI cost would be to apply for refinancing. If you choose this option, you should be aware that mortgage insurance premiums already paid will not be refundable.

Despite facing a higher interest rate, there are some benefits to having mortgage insurance premiums. Your monthly payment, even with extra interest, might end up being less than if you paid the monthly premiums yourself.

Single Premium Mortgage Insurance

Single-payment mortgage premiums, or SPMIs, are just that: a single payment. Also referred to as single-payment mortgage insurance, SPMI requires an upfront lump sum in order to obtain coverage. The expense is typically settled as part of the closing costs, with some borrowers opting to have the payment financed into their mortgage.

Compared to BPMI, your monthly mortgage payment with SPMI will be less, allowing you to finance a greater amount when buying a home. By getting this stipulation taken care of right away, you won’t have to worry about building enough equity to cancel the requirement.

Just like other payment methods, SPMI is non refundable. This presents a disadvantage if you were to refinance or sell after only a few years of paying off the loan, since you won’t be able to make that money back.

An SPMI can be difficult for some borrowers since mortgage insurance typically becomes a requirement when buyers lack the capital to make a substantial down payment. If an additional upfront expense would prevent you from buying a home, the SPMI avenue might not be the best option to pursue.

Split Premium Mortgage Insurance

One of the more uncommon forms of paying for mortgage insurance would be via a split-premium plan. Structured as a combination of BPMI and SPMI, split-premiums are partially paid in a lump sum at closing, with the rest of the cost tacked on to your monthly mortgage bill.

You might decide on a split-premium if the full cost of borrower-paid premiums restrict your borrowing capacity. By paying off some of the mortgage insurance upfront, your extra monthly finances can go towards paying off a larger loan.

Both the upfront and financed cost of mortgage insurance are again taken as a percentage of the total mortgage, and could possibly range from 0.5% to 1.25%.

How Long Do You Have to Pay PMI?

Mortgage insurance might be a burden when you start paying off your mortgage, but settling this expense won’t haunt you throughout the course of your loan. When the loan-to-value ratio drops below 80%, meaning you’ve gained at least 20% equity in the home, you’ll be able to request that the requirement gets dropped from your monthly bill.

If the loan to value ratio drops below 78%, your lender is obligated to automatically eliminate mortgage insurance conditions from your loan agreement. Say, for example, you could only contribute a down payment option of 15%. This would require you to pay for mortgage insurance under most lending agreements. However, if you made timely mortgage payments over the course of several years, you would make considerable headway while paying off the loan’s balance.

Your down payment, plus the amount of the loan principal you’ve paid off so far, equals the amount of equity you’ve built in the property. Under the federal Homeowners Protection Act, any PMI requirement is canceled when that amount exceeds 22% of the home’s purchase price.

FHA Mortgage Insurance (UFMIP & MMI)

What is FHA Mortgage Insurance?

Borrowers pay mortgage insurance premiums on home loans insured by the Federal Housing Administration (FHA). Because FHA financing accepts down payment options as low as 3.5% of the loan amount, additional mortgage insurance is applied to all FHA loans. Mortgage insurance protects lenders from borrowers who default on their FHA home loans. Paying MIP at the outset of the loan helps soften some of that risk.

You can expect the initial MIP, which is due at closing, to reflect 1.75% of your home’s purchase price. MIP or MMI will also be built into your monthly mortgage payments along with the principal, interest, homeowners insurance and property taxes.

What is the Difference to PMI?

There are so many acronyms in the world of mortgage lending that it can sometimes feel like you’re wading through alphabet soup. In particular, the differences between MIP and PMI — private mortgage insurance — can cause a lot of confusion, especially given their close similarities. Let’s put any misunderstandings about these two terms to rest.

MIP: An upfront payment you make — plus an annual premium — when you take out an FHA loan. The upfront mortgage insurance premium is sometimes referred to as UFMIP, while the ongoing monthly premium is called MIP. PMI: Insurance you pay each month on a conventional mortgage until you’ve gained 20% equity in your home.

Both MIP and PMI serve the same basic function — mitigate investments for lenders — but they’re applied in different scenarios. If you use a traditional type of home loan, like a 15-year fixed rate mortgage, and are unable to put up 20% for the down payment, you’ll need to pay PMI. Taking out an FHA loan? Then you’ll be paying for MIP.

Another big difference between the two is that borrowers may wind up paying MIP for a much longer time. FHA loans may require mortgage insurance premiums for more than a decade — possibly throughout the entire life of the loan. With PMI, borrowers only have to pay for mortgage insurance until they’ve hit the 20% equity threshold. That being said, FHA loan borrowers could potentially refinance their mortgage at a later time to use a different type of home loan that doesn’t require MIP.

VA Mortgage Insurance (Funding Fee)

What is a VA Funding Fee?

The VA funding fee is a one-time fee paid to the Department of Veterans Affairs that supports the VA home loan program. Veterans who put down less than 5% on their home purchase will pay 2.3% of the total loan amount when buying a home for the first time and 3.6% on subsequent loans. VA borrowers can pay less on the funding fee by putting down more money on the home.

How Does the VA Funding Fee Differ from Mortgage Insurance?

The VA funding fee is also sometimes referred to as VA loan private mortgage insurance (PMI) or VA loan mortgage insurance. The funding fee is the VA’s version of mortgage insurance – your payment is due when you close on your home, and it can be financed if necessary.

The terms funding fee, VA loan PMI and VA loan mortgage insurance are used interchangeably, and for the most part, they are very similar and go toward the same cause: partially protecting the lender and the VA in the case of a home buyer’s mortgage default.

Let’s break it down further by comparing mortgage insurance expectations across different types of home loans:

  • If you were to apply for a conventional loan, you’d pay for private mortgage insurance (PMI).
  • If you were to apply for an FHA loan, you’d pay for mortgage insurance premiums (MIP).
  • If you were to apply for a VA loan, you’d pay for the mortgage funding fee.

While these terms have specific meanings within their bureaucracies, if you’re looking to buy a home, they’re all pretty similar.

How is the VA Funding Fee Paid?

The VA funding fee is due at the time of closing and is included as one of the closing costs a borrower must pay. Your lender sends the paid fee to the VA on your behalf.

The funding fee can be a significant and costly closing cost for VA loan borrowers. Fortunately, you don’t necessarily have to pay it all out of pocket in one lump sum. You have a few options for how this fee gets paid.

  • Paid upfront as a closing cost.
  • Financed as part of the loan.
  • Seller pays.

While you can pay the funding fee at closing if you choose, you also have the option to roll the fee into your mortgage loan. While this will increase the size of your loan and your monthly payments, it can make the fee easier to pay since you aren’t having to pay several thousand dollars upfront.

You can also have the seller pay the fee as a seller concession. According to VA rules, sellers can pay certain costs on behalf of the buyer, as long as these concessions don’t exceed 4% of the loan. However, certain costs, such as payment of discount points, are not subject to this limit.

Are There VA Funding Fee Exceptions?

Not every borrower has to pay the VA funding fee. Be sure to find out if you’re eligible for an exemption, as changes have been made to VA funding fee exemption rules in 2020 to allow certain Purple Heart recipients to receive an exemption. The following are circumstances under which someone would be eligible for a funding fee exemption:

  • Individuals who receive compensation for a service-related disability.
  • Individuals who are eligible for a service-related disability pay but receive retirement pay or active service pay.
  • Surviving spouses who meet the eligibility requirements for the VA home loan program.
  • Active-duty service members who have been awarded the Purple Heart.

To find out if you’re eligible for an exemption to the VA funding fee, check out your VA loan Certificate of Eligibility. It will state whether you’re exempt or nonexempt. If you don’t yet have a COE, you can learn how to apply on the VA website.

USDA Mortgage Insurance (Guarantee Fee)

USDA loans are mortgage loans that help prospective homeowners buy homes in rural, and in some cases, suburban areas. The U.S. Department of Agriculture (USDA) backs USDA loans, which means that the government insures or guarantees the loan. It doesn't mean that the government issues the loan – a lender still issues the loan. However, the USDA protects the mortgage lender against losses if you fail to repay your loan.

The benefit to government backing means that you, the homeowner, will pay lower interest rates and no down payment. However, you will have to pay closing costs.

When you get a USDA loan, you pay an upfront guarantee fee and annual fee. The lender usually passes the nonrefundable upfront fee cost to the borrower.

A USDA loan guarantee fee refers to how the USDA mortgage is paid and functions similarly to mortgage insurance for a USDA loan. The upfront guarantee fee is equal to 1% of the loan amount. The annual fee is equal to 0.35% of the loan amount for 2022.

Upfront Guarantee Fee

In order to get a USDA loan, you must pay an upfront guarantee fee. This fee is usually added to the initial loan amount and paid at closing.

The new USDA guarantee fee in 2021 costs 1% of the loan amount. This means that if you have a $200,000 home loan, for example, your total loan amount would become $202,000. This amount has dropped considerably compared to previous years.

Annual USDA Loan Fee

The annual fee is usually financed into your loan. The annual fee currently costs 0.35% of the loan amount for 2022. You will pay this fee monthly along with your monthly mortgage payment throughout the life of your loan.

How does this work on your loan amount? Let's say you borrow $200,000. Your monthly payment would be $58.33 for your monthly loan fee. This amount has also dropped significantly compared to previous years.

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