How Much is Mortgage Insurance & Do I Need It?
If you're preparing to buy a house, you know that there are expenses in addition to the purchase price. Before you make an offer, you'll need to understand that the potential expenses could include the cost of mortgage insurance.
What is mortgage insurance? How much does mortgage insurance cost? Do you need it? There's no one-size-fits-all response to that question because it depends on a lot of different factors, some of which are in your control. Here's what you need to know about mortgage insurance.
What is Mortgage Insurance?
If this is your first time buying a house, you may not understand what mortgage insurance is -- so let's start there. Mortgage insurance is insurance that protects your lender. It might seem strange that a homeowner needs to purchase insurance to protect the lender, but let's talk about why it's necessary.
When you buy a house, you're typically not buying it only with your money. Instead, you're buying it mostly with the lender's money and that means they are invested for most of the cost of the house. If you default on your payments, the lender may need to sell the house to recoup their investment. Private Mortgage Insurance (PMI) will ensure that the mortgage lender recoups a portion of their loss if you default on your loan and they cannot sell the home for what you owe on the loan plus other expenses they incur. You will be required to pay for mortgage insurance with a limit that’s required by the lender. The lender will be able to file a claim if you default on your mortgage and the insurance will cover any gap.
We should note that what we're talking about here is private mortgage insurance or PMI. Private mortgage insurance protects the lender. If you have heard something about mortgage protection insurance, you should know that it's not the same thing. Mortgage protection insurance protects your investment by covering your mortgage payment if you lose your job, become disabled, or die.
The requirement for private mortgage insurance is determined by the type of mortgage you have, your down payment, and/or your lender. When you work with a mortgage lender, you should ask about their mortgage insurance requirements to get a clear picture of what will be expected.
When is Mortgage Insurance Required?
Your mortgage lender will tell you if you are required to buy mortgage insurance based on your loan type and other requirements. Here are the parameters most lenders use.
Low Down Payment Conventional Loan
The first instance where you will be required to buy private mortgage insurance is if you take out a conventional mortgage and make a low down payment. In this case, a low down payment is defined as any down payment of less than 20% of the purchase price or appraised value.
Low Equity Refinancing
On a related note, PMI may also be required if you have less than 20% equity in your home and you want to refinance with a conventional mortgage. If you made a large down payment when you first bought your home, then you may have enough equity to avoid the expense of mortgage insurance when you refinance, unless the home has lost value since you originally purchased it.
The Federal Housing Authority (FHA) provides low down payment loans to qualified borrowers. The minimum down payment is 3.5% and you will be required to purchase FHA mortgage insurance if you buy a house with an FHA mortgage, regardless of your down payment amount.
Like the FHA, the United States Department of Agriculture (USDA) provides low down payment loans to qualified buyers who purchase homes in rural or suburban areas. If you get a USDA loan, you will be required to buy USDA mortgage insurance.
Taking out a jumbo home loan is necessary if you want to buy a more expensive house and the amount you want to borrow does not qualify for a conforming loan. It's not a certainty that you'll need to buy private mortgage insurance, but your mortgage lender may require it if your down payment is less than 20%.
You may be wondering if there is a PMI requirement for a VA loan. The answer is no. VA loans do not require a minimum down payment and there is no mortgage insurance requirement.
The best way to determine if you’ll need to factor a PMI payment into your total expenses is to talk to your lender. They will provide you with their insurance parameters and requirements, so you can make an informed decision.
How Much Does Mortgage Insurance Cost?
The question that looms as a borrower is the cost of mortgage insurance premium. The PMI premium is determined by several factors and you'll need to make sure you understand where the numbers are coming from and how they will impact your closing costs.
Factors That Impact Mortgage Insurance Pricing
Let's talk about the things that a conventional mortgage insurance company will review to determine your PMI rate and what the annual premium will be.
Loan-to-value ratio. If you took out a conventional mortgage and made a down payment of 5%, the LTV would be 95%. The PMI rate will be higher with a 5% down payment than it would be with a 10% down payment.
Credit score. Most insurance carriers tier their PMI rates based on the borrower's credit score. If your score is high (over 760) you will pay a significantly lower rate than if your score were 630.
Investment property. If you buy an investment property, you will pay a higher PMI rate than you would with an owner-occupied property.
Cash-out refinance. Cash-out refinancing decreases your equity and increases the lender's risk -- and thus, it increases the insurance company's risk as well.
Manufactured home. PMI costs more for a manufactured home because these homes depreciate in value.
Second home/vacation home. With a second home or vacation home, you are taking on a second mortgage payment plus additional maintenance expenses, both of which increase the risk to the lender and insurer.
Mortgage term. If you are in a position to take on a mortgage term with an amortization period of 25 years or less, you may get a break on your mortgage insurance because you'll build home equity more quickly than you would with a 30-year term.
The range of prices for the annual premium can vary greatly depending on these factors. For example, if you had a high LTV of 97% and a credit score of 700, you can expect to pay about 1% of the loan amount as your premium. With a $200,000 loan, that would translate to $2,000 per year.
By contrast, if you had an 89% LTV and a credit score of 765, your PMI payment would be approximately .17% of your purchase price. You may pay either an up-front amount, which can be rolled into your mortgage if you choose, or a monthly payment.
How Mortgage Insurance is Calculated
Mortgage insurance premiums are calculated using a formula determined by the amount of your mortgage loan, the percentage of mortgage insurance coverage required by your lender, and other factors. Most lenders will enter the specifics of your loan into an automated pricing engine provided by private mortgage insurers. This engine uses a sophisticated algorithm to evaluate the risk factors associated with your loan and arrive at a competitive premium.
Many insurance companies have rate cards published on the internet that can give you some idea of standard monthly premiums based on LTV and credit score. Assuming a 30-year term and a 90% LTV with a 700 credit score, and based on the coverage required by most lenders (the shaded rates on the rate card), the monthly premium on a $200,000 loan would be .23% or $460/12 for $38.33 per month. Please note, rates are all subject to change.
FHA mortgage insurance is calculated differently. As of 2021, the up-front payment is 1.75% of the loan amount, and as we mentioned before that amount can be rolled into your mortgage. After that, you'll pay an annual premium based on your LTV and remaining loan amount that will be broken down and included in your monthly mortgage payment. Typically, the percentage is between .80% and 1.05%.
The formula is even simpler for USDA loans. You'll pay a 1% up-front premium and then .35% per year in annual premium.
Keep in mind that if you choose to roll your up-front mortgage insurance payment into your loan, your mortgage balance -- and thus your monthly mortgage payment -- will be higher than if you paid it at the closing. You may want to consider that when you're calculating the total expense of buying a home.
Mortgage insurance may be necessary depending on various factors, including your loan type, loan balance, and credit score. If you buy private mortgage insurance, your lender may be able to shop around and compare rates to get the best deal possible. Just make sure to meet your lender's PMI requirements when you choose a policy.
Are you looking for a lender to help you achieve your dream of homeownership? Click here to apply with SIRVA Mortgage today!