What is Mortgage Insurance? Your Need-to-Know Guide

Cardinal Financial May 12, 2023 | 5 min read
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What is mortgage insurance? In a nutshell, mortgage insurance is insurance that protects your lender if you fail to make payments on your loan. But just how much you’ll have to pay, and what kind of mortgage insurance you need, depends on a few different factors. So, let’s break down what mortgage insurance is, why you need it, and how it’s different from homeowners insurance.

Mortgage insurance protects your lender if you default on your loan. What kind of mortgage insurance you’ll need depends on if your loan is backed by the government or a private lender.

What is mortgage insurance? The basics.

Even though mortgage insurance is designed to protect your lender, that doesn’t mean you can’t benefit from it. In fact, it can actually make homeownership more attainable. By paying mortgage insurance, you could get approved for a loan that you otherwise wouldn’t qualify for. Putting 20% down isn’t always realistic for prospective homeowners, so paying a monthly fee for insurance can be a better route than paying more upfront.

Mortgage insurance vs. home insurance

As you’ve probably gathered by now, home insurance and mortgage insurance are not the same thing. Home insurance (also called homeowners insurance) is what protects you from liability if damage or loss occurs to assets within your home (or to the home itself). The exact amount of coverage you have depends on the policy you choose. If you have an escrow* account, your home insurance can be included in your mortgage payment. Mortgage insurance (unless you’ve qualified to drop it—more on that later) is already part of your mortgage payment regardless.

*Escrow is an account, usually created by your lender, that allows your lender to collect estimated taxes and insurance and pay those costs on behalf of you, the borrower. It helps consolidate your homeownership expenses so you don’t have to keep track of separate monthly bills.

Types of mortgage insurance

Now that you’ve got the basics of mortgage insurance down, let’s get into the different types you might encounter as a home buyer. The type of mortgage insurance you’ll need depends on whether your loan is backed by the government or a private lender.

Private mortgage insurance (PMI)

If you have a Conventional loan, you’ll likely need to pay private mortgage insurance (PMI). Your lender will set up insurance for you with a private, preferred insurance company. Your rate is calculated based on your down payment and credit score. Once you reach 20% equity in your Conventional loan, you’re eligible to stop paying mortgage insurance. Once you hit 22% equity, it’s dropped automatically.

Depending on your lender, you may also have to pay PMI if you have a Jumbo loan. These loans exceed the conforming loan limits of Conventional loans and are for luxury homes and homes in high-cost areas. Because your down payment on a Jumbo loan will likely be considerably higher than a Conventional loan, many lenders will not require PMI even if you put down less than 20%.

FHA mortgage insurance premiums (MIP)

If you have an FHA loan, your insurance will be collected by the Federal Housing Administration (FHA). Insurance is required on all FHA loans, regardless of your down payment amount. This is called a mortgage insurance premium (MIP).

One important thing to note about mortgage insurance on FHA loans is that it includes a fee you’ll pay at closing as well as a monthly payment that’s part of your mortgage bill.

USDA guarantee fees

USDA loans are backed by the United States Department of Agriculture. USDA loans don’t require mortgage insurance in the traditional sense. Instead, you’ll pay a guarantee fee. This cost includes an upfront fee at closing equal to 1% of your loan amount. Even though it’s called an upfront fee, you may actually be able to split that cost up throughout your monthly mortgage payments. Your monthly payments will also include your annual guarantee fee, which is equal to 0.35% of your loan balance.

How can I drop mortgage insurance?

For government-backed loans (with the exception of VA loans) mortgage insurance premiums and fees are just part of the package—the only way to stop paying them is to pay off your mortgage entirely or refinance to a Conventional loan. Conventional loans aren’t government-backed, so they offer a bit more flexibility when it comes to dropping mortgage insurance once you reach 20% equity.

Another way to avoid paying a monthly mortgage insurance fee is to pay it off upfront when you take out your home loan. If you have a Conventional loan, any funds you have for upfront costs may be better directed towards your down payment, though. After all, the more you put down, the sooner your insurance can be dropped.

So, now that you know more about mortgage insurance than you probably thought there was to know about mortgage insurance, you’re ready to start the home buying process with confidence. You’ve got this.

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