Mortgage Insurance, also known as MI, can be a monthly pain in your budget. If you purchased a home with less than a 20% down payment, you should be familiar with the terminology. Mortgage insurance often catches many people by surprise in the home loan process.
Before you buy a home, you should know what mortgage insurance is and if you will need it. Also, how much does it cost? These questions will all directly affect your homebuying budget. Throughout this article, we will dissect this topic and pull back the curtain on mortgage insurance.
What is Mortgage Insurance?
Mortgage insurance protects a lender if you are unable to repay your mortgage in certain scenarios. Much like any insurance policy, mortgage insurance is there to mitigate risk. The idea is that the less money you put down, the more likely you are to default on a loan. So, if you put down a lower down payment, the lender will want to cover their risk with insurance. Usually, the lender arranges for mortgage insurance, so you don't have to worry about where you get it, but you will have to foot the bill.
Mortgage insurance has a couple of different categories. The first of which is the most common, and that is Private Mortgage Insurance (or PMI). In this scenario, a borrower might be required to have Mortgage insurance on a conventional home loan. PMI is typically needed if a borrower puts less than 20% down on a conventional home loan or they are refinancing a conventional loan and the equity is less than 20% of the home value.
Another common type of mortgage insurance is a qualified mortgage insurance premium (MIP). A mortgage insurance premium is required for all Federal Housing Administration (FHA) loans, regardless of the size of the down payment. Otherwise, it is very similar to traditional private mortgage insurance. One important thing to note though is that VA loans do not require mortgage insurance. However, there are other upfront fees associated with the VA loan program.
Will You Need Mortgage Insurance?
It depends. As previously stated, most conventional loans require mortgage insurance if your down payment is less than 20%. However, there are other scenarios where your lender could require it. Since FHA loans have lower down payments by design, the mortgage insurance premium is non-negotiable and stipulated by the federal government.
In other words, mortgage insurance is a fact of life for most first-time homebuyers. About 80% of home buyers put down less than 20%, according to the National Association of Realtors' 2017 figures. In addition, more than 60% of first-time homebuyers put down less than 6% down on their first house.
How Much Does It Cost?
Private mortgage insurance typically totals a couple of thousand dollars a year. Thankfully, this is spread out over monthly payments, and it is conveniently folded into your mortgage payments. The total payment could be higher or lower depending mostly on the size of your down payment, your credit score, and the size of your loan.
There are other factors that can affect the cost of your private mortgage insurance, however. These factors include the type of mortgage insurance, whether your interest rate is fixed or adjustable, the length of the loan, the insurance coverage amount the lender requires, your home’s value, and even some other additional risk factors determined on a case-by-case basis.
Premiums vary from program-to-program, but in general, private mortgage insurance will cost 0.3% - 1.15% of the original loan amount per year, with 1% being a common amount. Let's say you're buying a $300,000 home with $15,000 down (a 5% down payment), taking out a $285,000 loan with 1 % in mortgage insurance.
$285,000 x .01 = $2,850 in annual private mortgage insurance
$2,850 ÷ 12 = $237.50 in monthly private mortgage insurance payments
As you can see, you need to account for private mortgage insurance when deciding how expensive of a house you can afford and it’s something that usually sneaks up on borrowers, along with the monthly taxes and costs due at closing. The good news is that after a certain point, private mortgage insurance can usually be eliminated from your monthly payments.
Mortgage insurance premiums are a little more complicated, more expensive overall, and less flexible. It has two main parts. First, unlike with private mortgage insurance, there's an upfront premium. This can be paid as part of your closing costs, or it can be added to the loan. The second is the annual premium that is spread over 12 monthly payments just like private mortgage insurance.
The good news with an FHA loan, is that your credit score does not affect the mortgage insurance premium amount in any way. The price will vary depending on the loan term, the loan amount, and the initial loan-to-value ratio (LTV ratio). The LTV ratio is a number that lenders use to assess risk. Loan to value ratio is a percentage expression that measures your home’s appraised value that you want to purchase against the loan amount you are seeking to borrow from the lender.
Currently, the upfront premium is around a 1.75% of the total loan amount. The annual premiums range from 0.45% - 1.05% of the base loan amount. For example, taking the same loan scenario, we used above:
$285,000 x .0175 = $4,987.50 in cash or financed within the loan
+ $285,000 x .01 = $2,850 in annual mortgage insurance premiums
$2,850 ÷ 12 = $237.50 in mortgage insurance premiums each month
If you were to finance your upfront premium and add that number on to your annual premium, then your monthly payment would be even higher than $237.50.
If you want to ditch your mortgage insurance premium, you could always refinance further down the line. That is not too big of a deal, since refinancing is often just part of smart homeownership.
Mortgage insurance is just one of many aspects of a mortgage that needs to be considered when shopping around for a mortgage. The search for a mortgage can be difficult. That is the reason the ALLIANCE Home Loan Center is here to help you. If you have any questions, please stop by the ALLIANCE Home Loan Center at 8401 Quaker Ave or visit us online for more information.
