What Is Mortgage Insurance Called?
Understand mortgage insurance. Explore its various forms, why it's required, how it's paid, and steps to eliminate this home financing expense.
Mortgage insurance is a financial product for individuals purchasing a home, especially when their down payment is less than 20% of the purchase price. This insurance protects the mortgage lender, not the borrower, against financial losses if the homeowner defaults. The specific terminology for mortgage insurance varies depending on the type of home loan.
Different Names for Mortgage Insurance
The name for mortgage insurance often depends on the loan program. For conventional loans, not backed by a government agency, it is Private Mortgage Insurance (PMI). PMI protects lenders from losses when the loan-to-value (LTV) ratio is high due to a smaller down payment.
FHA loans require Mortgage Insurance Premiums (MIP). MIP has two components: an upfront premium (UFMIP) paid at closing, and an annual premium paid monthly. Unlike PMI, FHA loans require MIP regardless of the down payment amount.
Other government-backed loans include fees for lenders. VA loans include a VA Funding Fee. This one-time fee, paid at closing or financed into the loan, protects the lender and allows eligible service members and veterans to obtain mortgages without a down payment or monthly mortgage insurance. USDA loans for rural properties feature a USDA Guarantee Fee. This fee, with both upfront and annual components, enables 100% financing and competitive interest rates for eligible borrowers in designated rural areas.
Purpose of Mortgage Insurance
The primary objective of mortgage insurance is to safeguard the lender from financial exposure if a borrower fails to repay their home loan. When a borrower makes a low down payment, their equity is minimal, increasing the risk for the lender if default occurs. Mortgage insurance covers a portion of the lender’s potential losses if a foreclosure happens and the property sale does not fully cover the outstanding loan balance.
This risk mitigation allows financial institutions to extend mortgage financing to more individuals who might not otherwise qualify. Without mortgage insurance, lenders would likely require larger down payments, potentially making homeownership unattainable for many. While the homeowner pays the premium, the direct benefit is realized by the lender, enabling them to offer loans with lower upfront costs.
How Mortgage Insurance is Paid
The payment structure for mortgage insurance varies by loan type. The most common method involves monthly premiums, added directly to the homeowner’s regular mortgage payment. This integrates the insurance expense into the overall monthly housing cost.
Some mortgage insurance types, especially government-backed loans, include an upfront premium. FHA loans require an Upfront Mortgage Insurance Premium (UFMIP), often paid at closing or financed into the loan. VA loans involve a VA Funding Fee, and USDA loans require an upfront guarantee fee, both payable at closing or rolled into the loan balance. These upfront fees reduce immediate out-of-pocket expenses.
Lender-Paid Mortgage Insurance (LPMI) is another option. Here, the lender pays the premiums directly to the insurer. However, the cost is passed to the borrower indirectly through a slightly higher interest rate. While LPMI eliminates a separate monthly insurance line item, the borrower still bears the cost over the loan’s life through increased interest payments.
Canceling Mortgage Insurance
The ability to cancel mortgage insurance depends on the loan type and the borrower’s home equity. For conventional loans with Private Mortgage Insurance (PMI), the Homeowners Protection Act (HPA) of 1998 provides cancellation guidelines. Borrowers can request to cancel PMI once their loan-to-value (LTV) ratio reaches 80% of the home’s original value, with a good payment history. PMI must automatically terminate once the LTV reaches 78% of the original value, based on the loan’s amortization schedule, if the borrower is current on payments.
Cancelling Mortgage Insurance Premiums (MIP) for FHA loans is more complex. For most FHA loans originated after June 3, 2013, annual MIP is typically required for the entire loan life if the down payment was less than 10%. If the down payment was 10% or more, MIP may cancel after 11 years. The most common way to eliminate MIP on newer FHA loans is by refinancing into a conventional loan once sufficient equity, typically at least 20%, has been built. Fees for VA and USDA loans are typically one-time or structured differently and are not subject to the same cancellation rules as PMI or MIP.