What Is Mortgage Insurance and How Does it Work?

A 20% down payment isn’t always possible for homebuyers, especially in markets where housing is more expensive than the national average. Mortgage insurance allows for borrowers to qualify for a loan even when they can’t put down a full 20%. This enables borrowers to become homeowners sooner and begin to build equity, even if they don’t have a large lump sum of cash.

 

How it Protects the Lender

Mortgage insurance is meant to protect the lender against losses. It ensures the lender is still able to receive back some of the principle if the borrower stops making the mortgage payments. However, this doesn’t mean the borrower gets to walk away from the loan free and clear. They are still on the hook for the amount owed.

 

Different Kinds of Mortgage Insurance

Mortgage insurance can either be PMI (private mortgage insurance) when dealing with a conventional loan or MIP (mortgage insurance premium) for FHA loans.

 

Private Mortgage Insurance (PMI)

PMI with a conventional loan occurs when the borrower puts down less than 20% for their down payment. Nearly 18% of mortgages in the U.S. have PMI. According to U.S. Mortgage Insurers Group, on average, homeowners with PMI will make payments for 5 1/2 years before the insurance ends.

The cost of PMI can vary according to the size of your home loan, your credit score and other factors. Usually, the monthly PMI fee is included in your mortgage payment. After you have 20% equity in your home, you can ask to cancel the PMI. You can use a PMI calculator to estimate the cost.

 

Mortgage Insurance Premium (MIP)

MIP is only for FHA loans. The majority of FHA home loans require an upfront mortgage insurance premium plus an annual premium, no matter the size of your down payment.

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. Your MIP is paid in monthly installments for the life of the FHA loan, if you put down less than 10%. If you are able to put down over 10%, you’ll pay MIP for 11 years.

 

Low or No Down Payment Loans Without Mortgage Insurance

USDA mortgages, backed by the U.S. Department of Agriculture, and VA mortgages, backed by the U.S. Department of Veterans Affairs, don’t require mortgage insurance. VA loans also don’t require any down payment. However, these kinds of loans have fees to protect lenders in the case a borrower defaults. These fees tend to be paid upfront.

 

Avoiding Mortgage Insurance With Piggyback Loans

Some borrowers try to avoid PMI by taking out two mortgages at a time. These are called piggyback loans. The most common type is an 80/10/10 loan, which requires the borrower to have at least a 10% down payment. With this type of piggyback loan, the borrower takes out a mortgage for the standard 80% of the home’s purchase price.

However, instead of paying the other 20% in cash for a down payment, the borrower takes out a second loan, usually 10% of the purchase price. Often this second loan is with a separate lender. The remaining 10% is then paid with the cash the borrower already had.

For example, you want to buy a home for $200,000, but you only have $20,000 saved. Using the piggyback strategy, you would take out a mortgage for $160,000 (80%). You would then take out a piggyback loan for another $20,000 (10%). Your saved $20,000 in cash would cover the rest of the down payment.

 

More About Piggyback Loans

The advantage to a piggyback loan is not having PMI. The disadvantage is you have to pay closing costs on both loans. Additionally, the second loan may have higher interest than a standard mortgage loan.

 

We Can Help

We’ve got good news: if you meet the requirements for a VA loan, you can avoid both a large down payment and mortgage insurance. These loans are our specialty, so we know how to structure them so you pay as little as possible in fees.

Finding the mortgage that fits your requirements and budget can seem daunting, but we’re here to help. If you’d like to get more information on VA loans, mortgage insurance, or what other kind of loans would work best for your situation, call us at 844-6-VA-LOAN or send us an email at dan@instamortgage.com.