Mortgage Insurance: How It Works And When It's Required

The traditional target for a home down payment is 20% of the purchase price, but that’s out of reach for many buyers.
Mortgage insurance makes it possible to hand over a much smaller down payment (and sometimes no down payment) and still qualify for a home loan. It protects the lender in case you default on the loan. With a conventional mortgage — a home loan that isn’t federally guaranteed or insured — a lender will usually require you to pay for private mortgage insurance, or PMI if you put less than 20% down. With an FHA or USDA loan, you’ll pay for mortgage insurance regardless of the down payment amount. VA mortgages require a “funding fee”, rather than mortgage insurance.

How does mortgage insurance work?

You bear the cost of mortgage insurance, but it covers the lender. Mortgage insurance pays the lender a portion of the principal in the event you stop making mortgage payments. Meanwhile, you’re still on the hook for the loan if you can’t pay, and you could lose the home in foreclosure if you fall too far behind. This is different from mortgage life insurance, which pays off the remaining mortgage if the borrower dies, or mortgage disability insurance, which eliminates the mortgage if the borrower becomes disabled.

PMI vs. MIP and others

Mortgage insurance works a little differently depending on the type of home loan. Here’s a look at the coverage for conventional and government-backed mortgages.

PMI for conventional mortgages

Many lenders offer conventional mortgages with low down payment requirements — some as low as 3%. A lender likely will require you to pay for private mortgage insurance, or PMI, if your down payment is less than 20%. Before buying a home, you can use a PMI calculatorto estimate the cost of PMI, which will vary according to the size of your home loan, credit score, and other factors. Typically, the monthly PMI premium is included in your mortgage payment. You can ask to cancel PMI after you have over 20% equity in your home.

FHA mortgage insurance premium (MIP)

FHA loans, which are insured by the Federal Housing Administration, feature minimum down payments as low as 3.5% and have easier credit qualifications than with conventional loans. FHA home loans require an upfront mortgage insurance premium and an annual premium, regardless of the down payment amount. The upfront premium is 1.75% of the loan amount, and the annual premium ranges from 0.45% to 1.05% of the average outstanding balance of the loan for that year. You pay the annual mortgage insurance premium, or MIP, in monthly installments for the life of the FHA loan if you put down less than 10%. If you put down over 10%, you pay MIP for 11 years.

USDA mortgage insurance

USDA loans, from the U.S. Department of Agriculture, are zero-down-payment loans for rural and suburban homebuyers. Some USDA loans charge for mortgage insurance via two fees: an upfront guarantee fee you pay once and an annual fee you pay every year for the life of the loan. The 2019 upfront guarantee fee is 1% of the loan amount. The annual fee is 0.35% of the average outstanding loan balance for the year, which is divided into monthly installments and included in your mortgage payment. The federal government evaluates the fees each fiscal year and can change them. But your fee amount will not fluctuate. They are fixed when the loan closes.

VA mortgage insurance

VA loans, from Veterans Affairs, require no down payments and feature low-interest rates for active, disabled or retired military service members, certain National Guard members and reservists, and eligible surviving spouses. They don’t require mortgage insurance, but most borrowers will pay a “funding fee” ranging from 1.25% to 3.3% of the loan amount for purchase loans. This fee depends on a wide variety of factors, including whether you’ve applied for a VA loan before and how much money you’re putting down if any.

How to avoid mortgage insurance

To avoid mortgage insurance or the VA’s funding fee, you’ll need to get a conventional mortgage and put at least 20% down toward a home. If that’s not possible, then budget in the cost of mortgage insurance or VA funding fee when you’re calculating how much home you can afford.