Mortgage insurance provides a lot of flexibility in the purchase process. You can get a loan with a much lower down payment because the mortgage insurer takes on part of the risk if the unthinkable happens and you can no longer make your payments.
Lower down payments are one benefit of mortgage insurance from a client perspective, but it still amounts to an extra monthly fee as part of your mortgage payment. No one likes paying more than they have to.
There are a couple of ways you can avoid paying for mortgage insurance on a monthly basis. You can also get rid of it – often by refinancing. We’ll look at each option. But first, let’s take a look at how mortgage insurance works and some of the more common questions.
What Is Mortgage Insurance, and How Does It Work?
A down payment of 20% or more on a home isn’t feasible for a lot of us. Mortgage insurance enables you to make a lower down payment. In exchange, your lender or mortgage backer (think Fannie Mae, Freddie Mac, FHA, USDA, etc.) will almost always require some form of mortgage insurance.
Mortgage insurance is a premium paid by the client in one way or another. We’ll go over the ways this is financed in just a bit.
Why Do I Have to Pay Mortgage Insurance?
The idea behind mortgage insurance is that the insurance pays the lender or mortgage investor something in the event that the loan goes into default and the investor has to take the home back and deal with the expense of selling it again.
Because you’re making a lower down payment, the lender or mortgage investor takes on additional risk in giving you a home loan. The insurance helps mitigate that risk.
How Long Do I Have to Pay Mortgage Insurance?
How long you end up paying for mortgage insurance depends on the type of loan you get and occasionally on the size of your down payment. We’ll go over this in more detail below when we get to how you go about getting rid of mortgage insurance, but below is a general quick reference guide.
You can cancel mortgage insurance yourself on conventional loans once you reach 20% equity for a single-unit primary property. Mortgage insurance on multi-unit and investment properties comes off at the midpoint of the loan (e.g., 15 years on a 30-year term).
With an FHA loan, you’ll likely be paying mortgage insurance premiums (MIP) for the life of the loan unless you make a down payment of 10% or more. In that case, MIP comes off after 11 years.
USDA loans have something called guarantee fees that serve the same function as mortgage insurance. You pay these for the life of the loan.
“Life of the loan” is the key phrase there. You’re often not stuck with mortgage insurance for life.
How Do I Get Rid of Mortgage Insurance?
OK, so you have mortgage insurance. When can you get rid of it? The answer depends on the type of loan you have as well as your property type.
Conventional loans are the most complicated when it comes to mortgage insurance removal scenarios because they support the most different property types and cancellation scenarios.
We’ll cover the most common mortgage insurance cancellation scenario – cancellation on your single-family primary property or second home based on equity – in this post. However, you should know there are different requirements if you’re trying to cancel based on a significant increase in market value or after significant value-adding improvements. It can also be slightly harder to remove PMI on a two- to four-unit primary or investment property.
For more details on these specific situations, check out this in-depth breakdown of mortgage insurance cancellation, which includes a quick reference chart you can apply to your situation.
On single-unit primary homes, private mortgage insurance for conventional loans automatically comes off when you reach 22% equity in your home based on the original amortization schedule (meaning you didn’t make extra payments to get to that point).
If you want to get rid of your monthly mortgage insurance payment earlier by systematically paying down your loan balance, you can request PMI cancellation once you reach 20% equity based on the original loan balance. It’s important to note that your home has to be reappraised to make sure it didn’t go down in value between now and the close of your loan.
Everything we’ve talked about up to this point deals with the cancellation of what’s known as borrower-paid mortgage insurance (BPMI). However, there’s a way to avoid monthly mortgage insurance payments altogether on conventional loans.
Lender-paid mortgage insurance (LPMI) is an option, which is where you or your lender pay for your mortgage insurance policy upfront in order to avoid tacking it on to your monthly payment. There are a couple different ways this can work.
In one common option, your lender pays for your mortgage insurance policy upfront. In exchange, you take a slightly higher rate than what you would have with BPMI or without mortgage insurance. Every situation is different, but taking a higher rate could save you money vs. paying a separate fee for mortgage insurance. Remember that your mortgage interest is tax-deductible as well.
In the alternative version of LPMI, you can choose to pay for your entire mortgage insurance policy at closing, thereby getting the same rate you would have if you hadn’t taken LPMI at all. You may hear this referred to as single-pay mortgage insurance.
There’s also a hybrid approach. You can make a partial payment on your mortgage insurance policy upfront in order to get a lower rate with LPMI.
FHA and USDA Loans
If you have an FHA loan, in the majority of cases, you’re going to pay mortgage insurance for the life of the loan. If you have a 10% down payment in the case of a purchase or 10% equity in the case of a refinance, you’ll pay MIP for 11 years. Otherwise, MIP is for the term of the loan.
If you haven’t purchased or refinanced with an FHA loan since June 3, 2013, the requirements are different, and your MIP will eventually fall off. It’s beyond the scope of this post, but the requirements are in the post we linked to above on mortgage insurance cancellation.
If you have a USDA loan, the guarantee fees on that last for the full term of the loan.
However, it doesn’t mean you can never stop paying these premiums if you’re currently in an FHA or USDA loan. Assuming you meet the other qualification factors (e.g., a 620 median FICO® score for an FHA, 640 for USDA), you can refinance into a conventional loan and request mortgage insurance removal once you reach 20% equity in your home.
That’s about all there is to say about mortgage insurance. If you still have questions, you can leave them in the comments below. If you would like to speak with one of our Home Loan Experts about your options, give us a call at (800) 785-4788.
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