The Guide to Single Family Home Mortgage Insurance
Purchasing a single family home is one of the most significant financial decisions you can make. Along with determining the home loan amount you can qualify for, you must also consider mortgage insurance requirements. Mortgage insurance protects the lender in case you default on the loan.
While mortgage insurance adds to your upfront homebuying costs, it may be a requirement for certain home loans. This comprehensive guide will explain what mortgage insurance is, when it's required, and what types of policies are available for single family homes.
What is Mortgage Insurance?
Mortgage insurance, also called MI, is an insurance policy that covers the lender if the borrower stops making mortgage payments. It protects the lender from losses if a borrower defaults on the loan.
With mortgage insurance, the insurance company pays the lender a claim up to a certain percentage of the total loan amount. For example, if you stop making payments on a $200,000 loan, the insurer may pay out 25% or $50,000 to cover losses.
Mortgage insurance always protects the lender, not the borrower. It should not be confused with mortgage life insurance which covers the borrower’s mortgage in the event of death. Mortgage insurance only applies while you maintain the home loan.
Why is Mortgage Insurance Required?
Mortgage insurance is typically required for any home loan with less than a 20% down payment. The lower your down payment, the higher perceived risk you pose to the lender.
For example, with only 5% down on a $200,000 home, you finance $190,000. If you default, the lender cannot recoup the full $190,000 loan by foreclosing and reselling the home. There may be a shortfall between the sale price and unpaid loan balance.
Mortgage insurance covers losses in this scenario. The insurance protects lenders when lending to higher-risk buyers with smaller down payments. If you make a 20% down payment or higher, lenders consider you lower risk and may not require mortgage insurance.
When is Mortgage Insurance Required?
The exact mortgage insurance requirements depend on the loan program, but generally conform to these guidelines:
Conventional Loans:
- Less than 20% down - mortgage insurance required
- 20% or more down - mortgage insurance usually not required
FHA Loans:
- Minimum 3.5% down payment
- Mortgage insurance is always required for the life of the loan
VA Loans:
- No down payment required
- Mortgage insurance may be required
USDA Loans:
- No down payment required
- Mortgage insurance required
Even if mortgage insurance is not legally required, your lender may still require it until you reach 20% equity in the home. Review all loan program terms to understand specific mortgage insurance requirements.
How Long is Mortgage Insurance Required For?
For conventional loans, mortgage insurance is required until you reach 20% equity in the home through your loan payments and appreciation. At that point, you can request mortgage insurance cancellation.
With an FHA loan, you pay mortgage insurance premiums for the entire duration of the loan. However, there are options to cancel FHA mortgage insurance early if you meet certain equity and payment history requirements.
VA and USDA loans also require mortgage insurance for the full loan term in most cases. Carefully review the mortgage insurance cancellation terms for your specific loan. This determines when you can request to stop paying premiums.
What Does Mortgage Insurance Cost?
Mortgage insurance premiums are based on your specific loan, down payment, and credit details. Typical mortgage insurance rates fall between 0.3% to 2% of the total loan amount per year.
On a $200,000 loan amount, here are estimated annual mortgage insurance premiums:
- 0.3% - $600 per year
- 1% - $2,000 per year
- 2% - $4,000 per year
The mortgage insurance rate is higher with smaller down payments. Rates also increase for lower credit scores.
Mortgage insurance can be paid monthly along with your mortgage payment or annually as a lump sum. Monthly is more common. Though mortgage insurance increases your costs, it allows buyers with less savings to qualify for home financing.
What Types of Mortgage Insurance are Available?
There are a few main types of mortgage insurance for single family homes:
Government Mortgage Insurance - Provided by FHA, VA, or USDA to back loans they insure. You cannot drop government MI during the loan, only after reaching equity milestones specific to each program.
Private Mortgage Insurance (PMI) - Offered from private insurers like MGIC or Radian Guaranty for conventional loans with less than 20% down. PMI can be canceled once you reach 20% equity.
Lender Paid Mortgage Insurance - A type of PMI paid directly by the lender who then passes on costs to the borrower through a higher interest rate. The lender cannot cancel LPMI, but it automatically terminates once you reach 78% loan-to-value ratio.
Split Premium MI - The borrower and lender split payment of the monthly PMI premium. This helps lower the borrower’s monthly costs.
Single Premium MI - The borrower pays the mortgage insurance premium for the life of the loan upfront at closing instead of monthly.
Review multiple mortgage insurance options to determine the most affordable policy that meets your lender’s requirements.
What is Mortgage Insurance Based On?
Mortgage insurers evaluate various loan factors and risks to set premium rates. Key criteria include:
- Loan-to-value (LTV) ratio - The higher the LTV, the higher the premiums.
- Credit score - Borrowers with lower scores pay more for mortgage insurance.
- Loan amount - MI on jumbo loans above conforming limits is more expensive.
- Loan term - Shorter terms pose less long-term risk and have lower premiums.
- Property type - Single family homes are viewed as lower risk than condos or multi-families.
- Payment history - On-time mortgage payments may qualify you for lower MI rates.
Improve these areas as much as possible to pay lower mortgage insurance premiums. Compare rates from multiple insurers, as pricing and risk models vary.
How Can I Avoid Paying Mortgage Insurance?
Here are some tips to exempt you from mortgage insurance requirements:
- Put at least 20% down - Reaching the 20% down payment threshold lets you avoid MI on most loans. Save aggressively for your down payment.
- Take out a "piggyback" second mortgage - Combining an 80% first mortgage with a 10% second mortgage helps you avoid MI while only putting 10% down out of pocket.
- Make a large down payment pledge - Some lenders may waive PMI if you pledge to reach 20% equity within 1-2 years and can prove you have the funds.
- Pay down the loan quickly - Making extra principal payments helps you build equity faster so you can cancel MI sooner.
- Refinance once you have 20% equity - After a few years of home payments and appreciation, you may be able to refinance into a new loan without MI.
- Buy lender paid MI - LPMI automatically ends once you reach 78% loan-to-value, so there is no long-term premium.
- Consider a VA or USDA loan - These programs offer 100% financing so you can avoid MI with no down payment.
What is Mortgage Insurance Escrow?
Your lender may require you to pay mortgage insurance premiums through an escrow account along with your property taxes and home insurance.
With escrow, an amount is added to your total monthly payment to cover your MI bill. The lender collects monthly escrow payments, then distributes the full mortgage insurance premium when it is due.
Escrow ensures the MI and taxes are paid on time. However, it prevents you from paying the annual premium upfront for a discount. Review your loan Estimate to see if escrow is required.
How is Mortgage Insurance Tax Deductible?
Under the Tax Cuts and Jobs Act, mortgage insurance premiums are tax-deductible if you meet the following criteria:
- Your total income does not exceed $100,000 per year (or $50,000 if married filing separately)
- You purchased the home after December 15, 2017
- The home is your primary residence
- You pay mortgage insurance premiums related to acquisition debt taken out to buy, build or improve your residence
The deduction is limited to the amount paid during the tax year and lowers your taxable income. Consult a tax professional to claim the MI deduction appropriately.
Is Mortgage Insurance Required for Refinancing?
If you are refinancing your mortgage, the mortgage insurance requirements will depend on your current equity position:
Refinancing with 20% equity or more - You can likely end mortgage insurance for good by refinancing into a new loan.
Between 15-20% equity - Refinancing may allow you to cancel PMI early and stop payments.
Less than 15% equity - Mortgage insurance will still be required on the new loan until you reach 20% equity.
Always check if you have reached at least 20% equity before refinancing. This allows you to potentially refinance into a loan with no mortgage insurance and start saving on your monthly payments.
Even if MI is still required on the new loan, you may qualify for lower premiums by refinancing to a lower interest rate or shorter term. Carefully run the numbers to see if refinancing makes sense for your situation.
What Happens if I Let Mortgage Insurance Lapse?
It is imperative to pay your mortgage insurance premiums on time each month or year. If you allow mortgage insurance coverage to lapse, the lender will take action.
Consequences for letting MI lapse include:
- Late fees and penalties added to your loan balance
- Higher interest rates due to re-default risk
- Demand for immediate loan payoff in full
- Foreclosure proceedings on the home
- Significant damage to your credit score
Never miss a mortgage insurance payment or cancellation could result. If you are struggling to afford MI, discuss options with your lender right away before letting it lapse.
Is Mortgage Insurance Required for a Second Home?
If you are purchasing a second home or vacation property and financing more than 80% of the purchase price, mortgage insurance will be required by most lenders.
Second homes are generally riskier for lenders than primary residences. The mortgage insurance protects the lender if you default on a second home, rental property, or investment property mortgage.
Review the lender’s requirements carefully for second homes, as specialty second mortgage programs may have different mortgage insurance requirements than primary residence loans.
Getting the Best Mortgage Insurance Rates
Here are some tips for securing the lowest mortgage insurance rates possible:
- Shop multiple insurers - Compare quotes from various national and regional companies.
- Improve your credit - Insurers offer better rates to buyers with higher scores.
- Put down more upfront - A larger down payment leads to lower LTV and lower premiums.
- Reduce debt - Lower debt-to-income ratio means better rates from insurers.
- Choose the right term - Opt for a 10 or 15 year mortgage for lower total MI costs.
- Pay annually, not monthly - Paying annual premiums upfront can secure a discount.
- Time it right - Mortgage rates and MI rates change over time, so watch for dips.
- Ask about discounts - Some insurers offer discounts for multiple policies or new homebuyers.
Following mortgage insurance best practices ensures you find an affordable policy to cover your new home loan properly.
Conclusion
Mortgage insurance is required primarily for buyers who put down less than 20% on a home loan. While an added cost, it makes homeownership attainable for more buyers by protecting lenders from default risks.
Understand when mortgage insurance is necessary for your situation, how much it will cost and the best ways to minimize your rates. Compare options from private mortgage insurers as well as government loan programs. Maintain payments responsibly once required mortgage insurance is in place.
With the right mortgage insurance plan and diligent home loan repayment, you can feel confident purchasing your dream home even with a smaller down payment. This essential guide provides everything you need to know to factor mortgage insurance wisely into your upcoming property purchase.