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Mortgage insurance refers to any insurance policy that protects lenders against the risk of a borrower defaulting on a mortgage loan. Typically, mortgage insurance premiums are paid by borrowers as an extra cost in their monthly payments. Mortgage insurance is often required when buying a home with a down payment of under 20% or when refinancing with a current equity of less than 20%. FHA mortgages require insurance for at least five years.
- Private Mortgage Insurance (PMI)
- FHA Mortgage Insurance
- Calculating Mortgage Insurance Costs
- How to Get Rid of Mortgage Insurance Premiums
Private Mortgage Insurance (PMI)
For conventional mortgages, lenders usually require you to pay a mortgage insurance premium if your down payment is under 20% of the total mortgage amount. PMI comes in two general forms, known as borrower-paid and lender-paid mortgage insurance. Single-premium insurance is also available, but less common.
|Borrower-Paid Mortgage Insurance (BPMI)||Lender-Paid Mortgage Insurance (LPMI)||Single-Premium Mortgage Insurance|
|Cost Structure||Monthly premiums||Increased mortgage rate||Upfront lump sum|
|Best For…||Borrowers uncertain about future housing plans||Short-term borrowers planning to refinance or sell||Long-term borrowers trying to minimize lifetime costs|
|Drawbacks||Higher initial costs that aren't tax-deductible||Can't remove costs except by refinancing||Increased upfront expenses|
Borrower Paid Mortgage Insurance (BPMI)
In most cases, borrowers pay mortgage insurance premiums every month. The annual cost of these premiums are calculated as a percentage of the initial loan balance. BPMI is a predictable policy that has no upfront costs, making it a flexible approach if you aren't certain about your future plans. It's also a good choice if you plan on staying in your home for the long term, since you can have the premiums removed once you pay off about 20% of your original purchase price. However, the premiums can raise your monthly expenses early on.
Lender Paid Mortgage Insurance (LPMI)
Lender-paid mortgage insurance is a slightly misleading term that refers to policies paid for up front or in the form of higher mortgage rates. Lenders don't actually pay for LPMI. Instead, borrowers get to avoid premiums completely by accepting a higher mortgage rate on their balance. In essence, you trade monthly premiums for an increase in monthly interest payments. While the total cost is usually lower (and tax-deductible), this means that you won't be able to eliminate the cost of mortgage insurance until you refinance or pay off the mortgage.
Single-Premium Mortgage Insurance
Single-premium mortgage insurance is a third alternative for conventional mortgages, where the insurance is paid for in one larger upfront payment. This raises the initial cost of a mortgage —a potential problem for borrowers whose smaller down payments are forcing them to take on mortgage insurance in the first place. Still, paying upfront may reduce the total amount you spend on mortgage insurance, making single-premium insurance another viable option depending on your lender's practices.
FHA Mortgage Insurance
FHA mortgages allow people to take out mortgages with down payments as low as 3.5%. While the government guarantees FHA mortgages in case of borrower default, borrowers must still pay for mortgage insurance. The FHA requires both an upfront and monthly premium payments.
Upfront Mortgage Insurance Premium (UFMIP)
All borrowers who pay their FHA insurance costs upfront pay 1.75% of the base loan amount. On a $200,000 loan, this would cost the borrower a $3,500 lump sum at the start of the mortgage period. Most borrowers going through the FHA prefer to minimize front-end costs, but this upfront premium is an unavoidable (if small) addition that should be taken into account.
Annual Mortgage Insurance Premiums (MIP)
The annual mortgage insurance premium rate for FHA loans depends on your loan-to-value ratio as well as your total loan amount and repayment plan. The table below illustrates how the FHA determines annual insurance rates.
Annual MIP Rates for FHA Mortgages
|Term Length||Base Loan||Loan-to-Value||Current MIP||Postponed MIP Update|
|Over 15 years||$625,000 or less||≤95%||0.80%||0.55%|
|15 years or less||$625,000 or less||≤90%||0.45%||0.25%|
In January 2017, the Department of Housing and Urban Development under the outgoing government scheduled a significant decrease in MIP premiums at every level, but this was postponed indefinitely following the transition to a new administration. To date, there has been no determination on the future of MIP rates, which have remained at their original levels since the postponement.
Calculating Your Mortgage Insurance Costs
To illustrate the effects of upfront payment and monthly premiums, we calculated the costs on a 30-year fixed rate FHA mortgage with a $200,000 balance and interest at 4%. We assumed a 10% down payment, which brings the annual MIP to 0.80%.
Mortgage Insurance Costs on a 30-Year $200,000 FHA Mortgage
|Total Insurance Costs||$51,500|
Private mortgage insurance costs are affected by the size of your down payment as well as your personal credit score. Because its purpose is to reduce risk to lenders, mortgage insurance is priced to reflect the relative danger of the borrower defaulting on the loan. This can incorporate local conditions as well as your personal details and the amount involved.
The annual cost of borrower-paid premiums generally falls between 0.5% and 1.0% of the initial borrowed amount. For instance, financing a $200,000 home with 10% down requires a mortgage amount of $180,000. Depending on your location, credit score and the insurance provider, the mortgage insurance premium would cost $900 to $1,800 each year —an extra cost of $75 to $180 on each monthly payment.
How to Get Rid of Mortgage Insurance Premiums
Removing mortgage insurance works differently for conventional mortgages and FHA mortgages. Each type has certain minimum figures you must meet before you can cancel the monthly premium payments on your mortgage.
Removing PMI Premiums
With BPMI on conventional mortgages, you can request a cancellation of your monthly insurance premiums once you have reached a loan-to-value ratio of 80%. This means that you've paid enough to have 20% equity in the original appraised value of the property. Additionally, the Homeowner's Protection Act of 1998 requires lenders to drop PMI when borrowers reach an LTV ratio of 78%.
However, some mortgage contracts allow lenders to base your PMI status on a current appraisal of your home, a process they may ask you to pay for. If your property value has gone up, your cancellation request may be denied based on the fact that your payments haven't reached 20% of that current appraised value. If you're having trouble tracking down the insurance provisions in your current mortgage agreement, lenders usually provide information on PMI removal through their websites or by phone.
Removing FHA Insurance
In 2013, FHA revised its mortgage insurance premium policy so that all new FHA mortgages with down payments under 10% have to pay mortgage insurance premiums for the whole loan term. People who put down at least 10% will be able to remove the premiums after 11 years. In most cases, this means that the only way to remove FHA mortgage insurance is to refinance into a conventional mortgage. However, you are allowed to recover a portion of the upfront UFMIP payment when you refinance to another FHA mortgage within the first three years.
If you signed an FHA mortgage agreement before June 3, 2013, then removing your mortgage insurance premium works much the same as it does for PMI insurance. Once you've made at least five years of premium payments and reached a loan-to-value ratio of 80%, you can request removal of premiums. Moreover, the law requires lenders to remove premiums automatically once you reach 78% LTV.