Mortgage insurance is an important element of home financing with new buyers in most cases cannot afford to make a large down payment. It works as a back-up for the lenders in case the borrower commits himself or herself to repaying the loan and later disappears or is unable to meet the contractual obligations. The premium that borrowers have to pay for mortgage insurance depends on a number of different factors, for instance, the type of the mortgage, the proportion of the down payment, and the credit rating of the borrower.
What is Mortgage Insurance?
Mortgage insurance is a type of insurance that protects the lender in case the borrower defaults on their mortgage payments. It is often required when a homebuyer is unable to make a down payment of at least 20% of the home’s purchase price. The insurance reduces the risk for the lender, allowing borrowers to secure a loan even with a smaller down payment.
Mortgage insurance should not be confused with homeowner’s insurance, which protects the borrower’s investment in the home itself. Instead, mortgage insurance specifically covers the lender’s potential losses if the borrower fails to meet their loan obligations.
Types of Mortgage Insurance
There are several types of mortgage insurance, each associated with different loan types:
Private Mortgage Insurance (PMI)
PMI is required for conventional loans when the borrower’s down payment is less than 20%. PMI can be canceled once the borrower has built up 20% equity in the home, either through paying down the mortgage or an increase in the home’s value.
FHA Mortgage Insurance Premium (MIP)
FHA loans, which are government-backed loans offered by the Federal Housing Administration, require MIP. This insurance consists of an upfront premium and an annual premium, which can last for the life of the loan unless the borrower puts down at least 10%, in which case it can be removed after 11 years.
USDA Guarantee Fee
For loans backed by the U.S. Department of Agriculture, there is a guarantee fee that acts similarly to mortgage insurance. It includes both an upfront fee and an annual fee.
VA Funding Fee
Veterans Affairs (VA) loans do not require mortgage insurance, but they do require a funding fee, which serves a similar purpose. This fee helps to offset the cost of loans that go into default. The amount can vary depending on the borrower’s military service status, down payment amount, and whether it’s a first-time or subsequent use of the VA loan benefit.
How Much Does Mortgage Insurance Cost?
The cost of mortgage insurance depends on several factors, including the type of loan, the size of the down payment, the loan amount, and the borrower’s credit score.
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Average Cost of Mortgage Insurance
Here are breakdown of average cost for mortgage insurance:
Private Mortgage Insurance (PMI)
Typically costs between 0.3% to 1.5% of the original loan amount annually. For example, on a $200,000 loan, PMI could range from $600 to $3,000 per year, or $50 to $250 per month.
FHA Mortgage Insurance Premium (MIP
The upfront premium is 1.75% of the loan amount, and the annual premium ranges from 0.45% to 1.05%, depending on the loan term, amount, and loan-to-value ratio.
USDA Guarantee Fee
The upfront fee is 1% of the loan amount, and the annual fee is 0.35% of the remaining principal balance.
VA Funding Fee
This fee can range from 1.4% to 3.6% of the loan amount, depending on the borrower’s military service and down payment amount.
Monthly vs. Upfront Mortgage Insurance Costs
Some mortgage insurance fees are paid monthly, while others are paid upfront or rolled into the loan. For example:
- PMI: Typically paid monthly, though some lenders may offer an upfront payment option.
- FHA MIP: Includes both an upfront payment (1.75% of the loan amount) and an annual premium paid monthly.
- USDA Guarantee Fee: The upfront fee can be rolled into the loan, with the annual fee paid monthly.
- VA Funding Fee: Can be paid upfront at closing or financed into the loan.
What Determines the Cost of Mortgage Insurance?
Several factors influence the cost of mortgage insurance:
- Loan Type: Different types of loans have different mortgage insurance requirements and costs.
- Down Payment: A larger down payment generally reduces the cost of mortgage insurance because it lowers the loan-to-value (LTV) ratio.
- Loan Amount: Higher loan amounts usually result in higher mortgage insurance premiums.
- Credit Score: Borrowers with higher credit scores are often eligible for lower mortgage insurance rates.
- Loan Term: Longer loan terms may lead to higher annual mortgage insurance premiums.
How to Calculate Your Mortgage Insurance Cost
To estimate your mortgage insurance cost, you can use the following general formula:
For PMI:
Annual PMI Cost=Loan Amount×PMI Rate\text{Annual PMI Cost} = \text{Loan Amount} \times \text{PMI Rate}Annual PMI Cost=Loan Amount×PMI Rate
For example, if you have a $200,000 loan and your PMI rate is 0.5%, your annual PMI cost would be:
$200,000×0.005=$1,000 per year\$200,000 \times 0.005 = \$1,000 \text{ per year}$200,000×0.005=$1,000 per year
Dividing by 12 gives you the monthly cost:
$1,000÷12=$83.33 per month\$1,000 \div 12 = \$83.33 \text{ per month}$1,000÷12=$83.33 per month
For FHA Loans:
Calculate the upfront premium as:
Upfront MIP=Loan Amount×1.75%\text{Upfront MIP} = \text{Loan Amount} \times 1.75\%Upfront MIP=Loan Amount×1.75%
And the annual premium as:
Annual MIP=Loan Amount×MIP Rate\text{Annual MIP} = \text{Loan Amount} \times \text{MIP Rate}Annual MIP=Loan Amount×MIP Rate
These amounts can vary based on the specific terms of your loan.
Tips to Reduce or Eliminate Mortgage Insurance
- Increase Your Down Payment: A down payment of 20% or more eliminates the need for PMI on conventional loans.
- Improve Your Credit Score: A higher credit score can qualify you for lower mortgage insurance premiums.
- Refinance Your Loan: If your home has appreciated in value or you’ve paid down enough of your mortgage to reach 20% equity, consider refinancing to remove PMI.
- Request PMI Cancellation: Once your mortgage balance falls to 80% of the home’s original value, you can request your lender to cancel PMI.
- Consider a Piggyback Loan: Some borrowers use a second mortgage (often called a piggyback loan) to avoid PMI. For example, an 80-10-10 loan involves taking out an 80% first mortgage, a 10% second mortgage, and making a 10% down payment.
- Choose a VA Loan: If you’re eligible, a VA loan can be a good option since it doesn’t require monthly mortgage insurance premiums.
Mortgage insurance adds to the cost of homeownership but can also open doors for borrowers who might otherwise struggle to buy a home. By understanding the different types of mortgage insurance and the factors that affect its cost, you can make informed decisions to manage or even eliminate this expense over time.
FAQs On Mortgage Insurance
Here are answers to frequently asked questions about mortgage insurance:
How much is mortgage insurance per month?
The cost of mortgage insurance per month typically ranges from 0.3% to 1.5% of the original loan amount annually. This means for every $100,000 borrowed, monthly mortgage insurance could cost between $25 to $125.
How much is mortgage insurance on a $400,000 loan?
For a $400,000 loan, annual mortgage insurance could range from $1,200 to $6,000, translating to a monthly cost between $100 and $500, depending on factors like the loan type and the borrower’s credit score.
What happens to mortgage insurance in case of death?
In the event of the borrower’s death, mortgage insurance typically does not cover the remaining balance of the loan. However, some life insurance policies or mortgage protection insurance products may be designed to pay off the mortgage in such cases.
Conclusion
What is important to know about mortgage insurance is important for anyone that plans on making a down payment that is less than 20% of the home purchasing price. Overall, it increases the cost of mortgage but at the same time increases the affordability of homeownership to those who otherwise could not afford to pay bigger down payments to access credit. Considering various mortgage insurance choices and bearing in mind these costs in an efficient manner thereby assist to make a better decision for home financing.
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