Mortgage Insurance: How It Works and How Much It Costs
Mortgage insurance protects your lender if you can’t make your monthly payments. You’ll typically pay mortgage insurance premiums if you can’t make a 20% down payment on a conventional loan, or if you only qualify for government-backed home loan programs. Understanding how mortgage insurance works may help you avoid or reduce the cost.
What is mortgage insurance?
Mortgage insurance provides your lender with financial protection against losses if you’re unable to pay your mortgage. It’s typically required on a conventional loan if you make less than a 20% down payment, and is called private mortgage insurance (PMI). The “private” means the insurance is provided by private companies, and not insured by the government.
You’ll pay two types of mortgage insurance on a loan backed by the Federal Housing Administration (FHA), regardless of your down payment amount. The first is an upfront mortgage insurance premium (UFMIP), which is charged as a lump sum and typically financed into your loan balance. The second is the annual mortgage insurance premium (MIP); this is charged yearly, divided by 12 and added to your monthly payment.
How much does mortgage insurance cost?
You’ll pay an average of $30 to $70 per month in PMI premiums for every $100,000 you borrow on a conventional loan. The charge for upfront FHA mortgage insurance is generally 1.75% of your loan amount. The annual MIP ranges between 0.15% and 0.75% of your loan amount. The premium is divided by 12 and added to your monthly payment.
The table below gives you a side-by-side look at the cost of different types of mortgage insurance you might pay for FHA and conventional mortgages, and the factors that impact your premiums:
|Home loan program||Type of mortgage insurance required||Cost of mortgage insurance||Factors that affect your premium|
|Conventional||Private mortgage insurance (PMI)||$30 to $70 per month for every $100,000 borrowed||Credit score |
Loan-to-value (LTV) ratio
Number of borrowers
Debt-to-income (DTI) ratio
Fixed rate vs. adjustable rate
|FHA||Upfront mortgage insurance premium (UFMIP)|
Annual mortgage insurance premium (MIP)
|1.75% upfront for most loans|
0.15% to 0.75% annual MIP
|LTV ratio |
How do I pay for mortgage insurance?
Annual FHA MIP must be paid as part of your monthly mortgage payment. However, you do have some flexibility when it comes to paying upfront FHA MIP and conventional PMI.
There are four ways to pay for PMI:
- Borrower paid. Borrower paid mortgage insurance (BPMI) is the most popular option, because you can divide up the cost and add it to your monthly payment.
- Single premium. Also called “upfront PMI,” you can pay your entire premium in a lump sum and avoid paying it as a monthly cost. One tip: If a seller offers to pay a percentage of your closing costs, consider using the credit to pay the single premium insurance.
- Split PMI. PMI companies may offer “mix-and-match” choices that allow you to split part of the PMI premium into a monthly payment while you pay the other portion in a lump sum at closing.
- Lender paid. Lenders may offer to pay mortgage insurance on your behalf, if you’re willing to accept a higher mortgage rate for the life of the loan.
There are two ways to pay for upfront FHA MIP:
- Finance it into your loan amount. This is the most common way to pay the upfront FHA mortgage insurance fee.
- Pay it in cash. You can either pay it from your own funds, get a gift for the cost or ask the seller to pay for it.
PMI vs. MIP: Which is best for you?
Although PMI and MIP essentially do the same thing — reimburse the lender for financial losses if they have to foreclose on your home — different factors may affect the cost of one over the other.
PMI companies are on the hook to pay claims if you default on a loan, and they charge premiums based on how likely you are to default. A low down payment and credit score will result in a much higher PMI premium.
The percentages paid for both the upfront and annual MIP are the same regardless of how high or low your credit scores are, making FHA loans a more cost-effective choice for homebuyers with rocky credit histories.
Debt-to-income (DTI) ratio
You’ll pay a higher PMI premium on a conventional loan if your DTI ratio is over 43%. There is no markup for FHA loans based on your DTI ratio.
Number of borrowers
You’ll pay slightly lower PMI premiums if two people are on the loan versus one, while FHA mortgage insurance premiums are the same no matter how many people apply.
Loan-to-value (LTV) ratio
Lenders divide your loan balance by the price of your home to determine your loan-to-value (LTV) ratio — the higher it is, the more mortgage insurance you pay. With a down payment of 20% or more, you won’t pay any PMI. FHA mortgage insurance is required regardless of your down payment or LTV ratio.
|PMI is a better fit if:||FHA MIP is a better fit if:|
|You have a high credit score and a large down payment||You have a low credit score and a small down payment|
|You have a low DTI ratio||You have a high DTI ratio|
|You want to get rid of it when your home value increases||You can’t qualify for a conventional loan|
|You’re borrowing with someone else||You’re borrowing on your own|
Mortgage insurance vs. government guarantees: VA and USDA loans
If you’re eligible for a loan backed by the U.S. Department of Veterans Affairs (VA) or the U.S. Department of Agriculture (USDA), you won’t pay for mortgage insurance — and may be eligible for no-down-payment financing. There’s a catch: These government-backed programs require guarantee fees instead, which means they’re “guaranteed” to be paid a portion of the loan balance if a borrower defaults on a VA or USDA mortgage.
Like mortgage insurance, you’re required to pay the fees to protect lenders — and in the case of VA loans, taxpayers — from losses in the event of default.
The table below shows the type and cost of these guarantee fees for each program.
|Home loan program||Fee type and cost||Factors that affect the guarantee fee amount|
|VA||0.5% to 3.6% funding for most loans||Down payment amount |
Number of times the benefits have been used
Service-related disability status
|USDA||1% upfront guarantee fee|
0.35% annual guarantee fee
VA funding fee
Most VA borrowers must pay a funding fee that ranges from 0.5% to 3.6% of their loan amount and is charged to offset the taxpayer burden related to VA loans. Military veterans with a service-related disability may qualify for a fee exemption.
The fee is typically financed into the loan amount, but can be paid in cash from your funds or by the home seller.
USDA guarantee fee
USDA loans are also “guaranteed” by the government, but they work more like FHA mortgage insurance. Designed for low- to moderate-income borrowers who want to purchase homes in rural areas, USDA loans require two types of guarantee fees.
- The first is a lump-sum “upfront guarantee fee” based on a percentage of your loan amount that’s usually rolled into your loan amount.
- The other is an annual guarantee fee that’s divided by 12 and added to the monthly mortgage payment.
How to avoid mortgage insurance
There are ways to completely eliminate different types of mortgage insurance.
Private mortgage insurance
- Make at least a 20% down payment. You can get a mortgage without PMI by making a down payment of at least 20%.
- Take out a piggyback loan. Rather than paying mortgage insurance, you can take out a home equity loan or home equity line of credit (HELOC) and “piggyback” it on top of your first mortgage. In most cases, you’ll need a 10% down payment for the 80-10-10 loan, the most common piggyback option. Here’s how it works:
- Borrow 80% of the home’s value as a first mortgage
- Borrow 10% of the home’s value as a home equity loan or HELOC
- Make a 10% down payment toward your home purchase
FHA mortgage insurance
- The only way to avoid FHA MIP and UFMIP is to choose a different loan program.
VA funding fee
- Apply for a VA disability waiver. Military veterans with a service-related disability may be eligible for a funding fee exemption. Find out if you’re exempt by obtaining your VA certificate of eligibility.
USDA guarantee fee
- The only way to avoid USDA guarantee fees is to choose a different loan program — there is no way to reduce the cost of them.
How can I reduce mortgage insurance expenses?
- Boost your credit scores. Your credit score plays a big role in your PMI costs; keeping low credit card balances and paying on time could mean big savings.
- Ask the seller to pay a lump-sum PMI premium. Consider using a seller concession to buy out your PMI costs with lump-sum PMI. You might end up needing cash for the other costs, but you’d have a lower monthly mortgage payment.
- Choose lender-paid mortgage insurance. Taking a higher interest rate so your lender pays your mortgage insurance upfront may keep your out-of-pocket costs low at the closing table. However, you’re stuck with the higher rate for the life of the loan.
- Check your home equity regularly. You can ask to cancel PMI once you’ve reached 20% equity. You might have to pay for a home appraisal, but it’s worth it if home prices are booming in your neighborhood.
- Buy a single-family home. You’ll get the lowest premium for a single-family home; condos, co-ops, multifamily and manufactured homes cost more.
- Keep your DTI ratio low. A DTI ratio higher than 43% usually comes with a higher PMI premium.
- Choose a shorter loan term and a fixed interest rate. You’ll shell out more PMI dollars for a term of 20 years or longer, or if you get an adjustable-rate mortgage (ARM).
FHA UFMIP and MIP
- Make at least a 10% down payment. The annual MIP is slightly lower with at least a 10% down payment, and it’ll drop off your loan after 11 years.
- Choose a shorter loan term. If you can afford the payments of a 15-year mortgage term, you can reduce your monthly MIP premium.
- Refinance to a conventional loan as soon as you can. If you chose an FHA loan because your credit scores were low, refinance your FHA loan to a conventional mortgage as soon as your credit is in better shape to get rid of PMI costs.
- Ask the seller to pay the UFMIP. The FHA permits sellers to pay up to 6% of your sales price to cover FHA closing costs, including your UFMIP.
- Do an FHA streamline refinance. If you currently have an FHA loan, the FHA streamline refinance allows you to refi with reduced MIP costs. An added bonus: You don’t need income documents or an appraisal.
VA funding fees
- Make a bigger down payment. A down payment of 5% to 10% may save you thousands of dollars on the funding fee.
- Ask the seller to pay the funding fee. VA guidelines allow sellers to pay up to 4% of the sales price toward the buyer’s VA closing costs.
- Save your VA benefits for your dream home. The VA funding fee is 2.3% of your loan amount the first time you use it, compared to 3.6% for every use thereafter. On a $300,000 loan, for example, you’ll save an extra $3,900 on the fee if you use your VA eligibility for the first time.