13. What is Mortgage Insurance?

by Local Title

Mortgage insurance is a type of insurance that protects lenders from the risk of default by borrowers. It is often required for homebuyers who make a down payment of less than 20% of the home’s purchase price. This insurance enables lenders to offer loans to borrowers who may not qualify for conventional financing due to lower down payments or higher risk factors.

Types of Mortgage Insurance

Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) is typically required for conventional loans when the down payment is less than 20%. PMI is provided by private insurance companies and can be paid in various ways, including monthly premiums, an upfront premium at closing, or a combination of both. Once the borrower reaches 20% equity in the home, PMI can usually be canceled, either automatically or upon request.

FHA Mortgage Insurance

The Federal Housing Administration (FHA) requires mortgage insurance for all FHA loans, regardless of the down payment amount. FHA mortgage insurance includes an upfront premium, which can be financed into the loan, and an annual premium paid monthly. FHA mortgage insurance remains in effect for the life of the loan if the down payment is less than 10%. For down payments of 10% or more, the insurance can be canceled after 11 years.

VA and USDA Loan Mortgage Insurance

Veterans Affairs (VA) loans and U.S. Department of Agriculture (USDA) loans do not require traditional mortgage insurance. However, they include other fees to protect lenders. VA loans have a funding fee, which can be paid upfront or financed into the loan. USDA loans have an upfront guarantee fee and an annual fee, both of which serve similar purposes to mortgage insurance.

Benefits and Costs

Mortgage insurance benefits lenders by reducing their risk, allowing them to offer loans to a broader range of borrowers. For borrowers, mortgage insurance makes homeownership possible with a lower down payment. However, it also increases the overall cost of the loan. Understanding the terms and conditions of mortgage insurance, including how and when it can be canceled, is crucial for borrowers to manage their mortgage effectively.

Mortgage insurance is essential for many homebuyers who cannot afford a 20% down payment. It facilitates access to homeownership while protecting lenders, although it comes with additional costs that borrowers should carefully consider.