What is Mortgage Insurance?

Mortgage insurance is an insurance policy purchased by the consumer that protects the lender against loss in the event that the consumer defaults on the mortgage. For most homebuyers, the biggest hurdle to owning a home is the down payment. Private mortgage insurance, or private MI, can allow you to purchase a home with less down than what otherwise may be required. Lenders and investors typically require mortgage insurance for loans with down payments of less than 20%. Mortgage insurance provides lenders a financial guaranty should a loan go into foreclosure. It is this guaranty that allows many lenders not to require a 20% or more down payment when making home loans.

Who Benefits From Mortgage Insurance?

While mortgage insurance provides an obvious benefit to lenders, many times homebuyers will overlook the benefits MI affords them. These can be significant and may include:

Buying a home sooner – a higher loan-to-value ratio means less time is needed to save for a down payment.
Increased buying power – if you have a certain amount set aside for a down payment, using MI may help you afford more home than if you put 20% down.
Expanded cash-flow options – you may put less down and keep cash for other uses (making investments, paying off debt, or paying for home improvements or emergencies).
Faster approvals – loans with MI typically are approved sooner than non-MI or government-backed structures.

How is Mortgage Insurance Paid?

Every loan type charges mortgage insurance differently. Primarily, mortgage insurance is paid in two forms; (1) upfront mortgage insurance premium and (2) a monthly insurance fee paid with your mortgage payment. Here is a look at how mortgage insurance is paid in the various loan types:

FHA Loans. FHA charges consumers 1.75% of the amount borrowed as an upfront mortgage insurance premium. This premium is added to their initial loan balance so the consumer does not have to pay this as a typical closing cost at the close of escrow. Additionally, FHA charges a monthly mortgage insurance premium of 0.80% - 0.85% of the average annual principal balance owed on the loan for the life of the loan. The only notable exception is for consumers who put at least 10% down at the time of purchase will have their mortgage insurance cancelled after approximately 11 years.
VA Loans. The VA does not charge veterans "mortgage insurance" but instead charge them a "funding fee." Administered the same was that FHA's upfront mortgage insurance premium in charged, the VA charges between 0.50% - 3.3% depending on the loan type, veteran service type and whether the veteran has used their VA loan benefits previously.

USDA Loans. The USDA charges consumers an upfront "Funding Fee" of 1.00% of the amount borrowed and a monthly mortgage insurance premium of 0.35% for the life of the loan in the same way that FHA charges their monthly mortgage insurance. Also, like FHA the upfront premium is added to their initial loan balance so the consumer does not have to pay this as a closing cost at the close of escrow.

Conventional Loans. Like VA loans, mortgage insurance on conventional loans does not have an upfront fee but is paid only through monthly installments with your payment. The mortgage insurance rate varies based upon the terms of the loan but generally ranges between 0.50% - 1.15%.