When Is Mortgage Insurance Required?

Mortgage insurance protects lenders from financial loss if a borrower defaults on their home loan. It is often required for individuals financing a home purchase when certain lending criteria are not met. Understanding when this insurance applies and how it can be managed is important for homeowners.

Types and Costs of Mortgage Insurance

Mortgage insurance comes in several forms, tailored to specific loan types and borrower circumstances. Private Mortgage Insurance (PMI) is for conventional loans. Government-backed loans from the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), and United States Department of Agriculture (USDA) have distinct insurance requirements. Costs and payment structures vary significantly.

For conventional loans, PMI is an annual premium, 0.3% to 1.5% of the original loan amount. It is divided into 12 monthly installments and added to the mortgage payment. Factors influencing the rate include credit score, loan-to-value (LTV) ratio, and loan term; higher credit score and lower LTV result in a lower PMI rate.

FHA loans require a Mortgage Insurance Premium (MIP), with an upfront payment of 1.75% of the loan amount, financed into the balance. Annual MIP varies from 0.45% to 1.05% of the loan amount, paid monthly, depending on loan term and LTV.

VA loans do not require monthly mortgage insurance premiums. Instead, they have a one-time VA Funding Fee, ranging from 1.25% to 3.3% of the loan amount for most borrowers. This fee depends on service history and down payment, and can be paid at closing or financed.

USDA loans include an upfront guarantee fee of 1% of the loan amount and an annual fee of 0.35% of the average outstanding loan balance. These fees support the program.

When Mortgage Insurance is Applicable

Mortgage insurance requirements depend on loan type and borrower contribution. For conventional mortgages, insurance is required if the down payment is less than 20% of the home’s price. This mitigates lender risk, as lower down payments are associated with higher default likelihood. Insurance remains until sufficient equity is built.

FHA loans require Mortgage Insurance Premium (MIP), regardless of the down payment. For FHA loans originated after June 3, 2013, with an original loan-to-value (LTV) ratio greater than 90%, the annual MIP is required for the loan’s life. If the LTV was 90% or less at origination, the annual MIP may be removed after 11 years. This protects the FHA.

VA loans for eligible service members, veterans, and surviving spouses do not require monthly mortgage insurance premiums. They involve a one-time VA Funding Fee. Certain veterans receiving VA compensation for service-connected disabilities are exempt. USDA loans assist low- and moderate-income individuals in rural areas and require both an upfront guarantee fee and an annual fee, regardless of down payment. These fees cover potential losses for the USDA loan program.

Strategies for Mortgage Insurance

Borrowers have strategies for mortgage insurance, from avoiding it initially to removing it later. To avoid Private Mortgage Insurance (PMI) on a conventional loan, make a down payment of 20% or more of the home’s price. This signals lower lender risk, eliminating PMI.

For those unable to make a 20% down payment, Lender-Paid Mortgage Insurance (LPMI) is an alternative. The lender pays the PMI premium, but the borrower accepts a slightly higher interest rate for the loan’s duration. This can lead to lower monthly payments than borrower-paid PMI.

Another strategy to avoid PMI on conventional loans is a “piggyback” loan structure, like an 80/10/10 or 80/15/5 loan. In an 80/10/10 scenario, the first mortgage covers 80% of the home’s value, a second mortgage or home equity line of credit (HELOC) covers 10%, and the borrower makes a 10% down payment. This structure allows the borrower to reach the 20% equity threshold without a large down payment, bypassing PMI. The second loan carries its own interest rate and repayment terms, which should be evaluated.

Once a conventional loan is in place, borrowers can pursue PMI removal. The Homeowners Protection Act (HPA) of 1998 mandates automatic PMI termination when the loan-to-value (LTV) ratio reaches 78% of the original property value, provided payments are current. Borrowers can also request PMI cancellation when their LTV ratio reaches 80% of the original value, often requiring good payment history, no junior liens, and sometimes an appraisal to confirm current property value.

For FHA loans, removing the Mortgage Insurance Premium (MIP) requires refinancing into a conventional loan once sufficient equity is built. This means the property’s value has increased, or the borrower has made enough principal payments to achieve an LTV ratio of 80% or less, allowing qualification for a conventional loan without PMI. For FHA loans originated after June 3, 2013, the annual MIP is required for the loan’s life if the initial down payment was less than 10%. Refinancing remains the method to eliminate MIP.