Why Mortgage Insurance Feels Like a Scam & How to Drop It

Mortgage insurance can often feel like an unexpected and unwelcome cost added to a homeowner’s monthly expenses. While it may appear as an additional financial burden, mortgage insurance serves a specific and important role within the lending industry. Understanding its purpose and how it functions can help borrowers navigate its implications and eventually work towards its removal.

Understanding Mortgage Insurance

Mortgage insurance is a financial product designed to protect the lender if a homeowner defaults on their mortgage payments. Lenders require this insurance to mitigate increased risk when borrowers make a down payment of less than 20% of the home’s purchase price. This reduced upfront investment means the borrower has less initial equity, which lenders view as a higher default risk.

There are different types of mortgage insurance, primarily categorized by the loan type. For conventional loans, which are not backed by a government entity, it is known as Private Mortgage Insurance (PMI). For loans insured by the Federal Housing Administration (FHA), it is called a Mortgage Insurance Premium (MIP). VA loans do not have monthly mortgage insurance but include a one-time VA funding fee, serving a similar risk-mitigation purpose for the VA. USDA rural development loans also include an upfront and annual guarantee fee.

Situations Requiring Mortgage Insurance

The requirement for mortgage insurance is primarily determined by the type of loan a borrower obtains and the amount of their down payment. For conventional loans, Private Mortgage Insurance (PMI) is required when the down payment is less than 20% of the home’s purchase price. This is directly tied to the loan-to-value (LTV) ratio, which measures the loan amount against the home’s value; an LTV above 80% triggers PMI.

Federal Housing Administration (FHA) loans, designed to make homeownership more accessible, always require a Mortgage Insurance Premium (MIP), regardless of the down payment. FHA loans have both an upfront premium (UFMIP) of 1.75% of the loan amount, which can be financed, and an annual MIP of 0.85% of the loan amount, paid monthly. For most FHA loans originated on or after June 3, 2013, if the down payment was less than 10%, the annual MIP is required for the loan’s entire life. If the original down payment was 10% or more, the MIP may be canceled after 11 years.

For eligible service members, veterans, and surviving spouses, VA loans do not require monthly mortgage insurance premiums. Most VA loans include a one-time VA funding fee, which varies based on factors such as down payment size, prior use of VA loan benefits, and loan type. This fee, ranging from 1.25% to 3.3% of the loan amount, can be paid upfront or rolled into the loan. USDA rural development loans, offering 100% financing in eligible rural areas, require both an upfront guarantee fee of 1% and an annual guarantee fee of 0.35%, paid monthly.

Methods for Removing Mortgage Insurance

For conventional loans with Private Mortgage Insurance (PMI), there are several pathways to remove this cost. The Homeowners Protection Act (HPA) of 1998 outlines specific rights for borrowers regarding PMI cancellation and termination. Under the HPA, PMI automatically terminates when the loan’s principal balance is scheduled to reach 78% of the original value of the home, if payments are current. This termination also occurs at the midpoint of the loan’s amortization schedule, such as after 15 years on a 30-year mortgage, if the borrower is current on payments.

Borrowers can proactively request PMI cancellation once their loan-to-value (LTV) ratio reaches 80% of the home’s original value. To do this, borrowers must:
Submit a written request to their mortgage servicer.
Maintain a good payment history with no late payments.
Confirm no subordinate liens exist on the property.

The lender may require an appraisal to confirm the home’s current value, which is paid for by the borrower. If the home’s value has increased significantly due to market appreciation or home improvements, a new appraisal might help reach the 80% LTV threshold sooner.

Refinancing the mortgage is another effective strategy to eliminate PMI, especially if interest rates have dropped or the home’s value has increased substantially. Refinancing into a new conventional loan with at least 20% equity avoids PMI. Borrowers should consider the closing costs associated with a refinance, which can range from 3% to 6% of the loan amount, to ensure the savings from eliminating PMI outweigh these upfront expenses. Making extra principal payments can also accelerate reaching the 80% or 78% equity thresholds, speeding up PMI removal.

Removing Mortgage Insurance Premium (MIP) from FHA loans is more challenging than removing PMI. For most FHA loans originated after June 3, 2013, if the down payment was less than 10%, the MIP is required for the loan’s entire life and cannot be automatically canceled. The primary method to remove MIP in such cases is to refinance the FHA loan into a conventional loan once sufficient equity (20%) has been built. This allows the borrower to move to a loan product where PMI is cancelable or not required, if the new LTV is 80% or less.

Strategies to Avoid Mortgage Insurance

Homebuyers can implement several strategies to avoid paying mortgage insurance from the outset. For conventional loans, a down payment of at least 20% of the home’s purchase price avoids PMI. A larger down payment reduces the loan-to-value (LTV) ratio to 80% or less, eliminating PMI because the lender’s risk is significantly reduced. While this requires more upfront savings, it results in lower monthly payments and immediate equity in the home.

Another strategy involves using a “piggyback” loan, often structured as an 80/10/10 or 80/15/5 loan. In an 80/10/10 scenario, the borrower takes a first mortgage for 80% of the home’s value, a second mortgage (often a home equity line of credit or home equity loan) for 10%, and provides a 10% cash down payment. This keeps the first mortgage at an 80% LTV, avoiding PMI. It is important to note that the second mortgage typically carries a higher interest rate than the first mortgage.

Some lenders offer Lender-Paid Mortgage Insurance (LPMI), where the lender covers PMI costs. In exchange, the borrower accepts a slightly higher interest rate on the mortgage loan for the life of the loan. This eliminates a separate monthly PMI payment, but the cost is embedded in the interest paid over the loan term and cannot be removed unless refinanced. Borrowers should carefully compare the total cost of LPMI versus borrower-paid PMI over their expected loan tenure.

VA loans do not require monthly mortgage insurance premiums. A one-time VA funding fee is usually required, but can be financed and is exempt for certain disabled veterans and surviving spouses. This makes VA loans an attractive option for qualified borrowers seeking to avoid ongoing mortgage insurance costs without a substantial down payment.