You’ve heard of homeowners insurance, but what’s mortgage insurance? And do you need it?
A lot of people mix up mortgage and homeowners insurance, but they’re actually really different. Almost everyone who buys a house will get the latter, but you might also need to pay for mortgage insurance on top of that. Here are the mortgage insurance basics you should know.
First, what’s mortgage insurance?
Mortgage insurance protects your lender if you default on mortgage payments. This is different from homeowners insurance, which covers your house and your stuff if your home is damaged or destroyed.
The point of mortgage insurance is that it makes it less risky for a lender to give you a mortgage, so you can get a loan you might not get otherwise. For example, let’s say you can’t pay your mortgage and the bank forecloses on your home. If you have mortgage insurance, the lender can get reimbursed by the insurance company for the loan you can’t pay back.
Do I need mortgage insurance?
If your down payment is less than 20 percent of the purchase price of the home, you’ll probably need to get mortgage insurance. There are also certain types of loans that always require borrowers to pay mortgage insurance. Also, you may need mortgage insurance if you’re refinancing and have less than 20 percent equity in your home.
Mortgage insurance increases the cost of your loan. You’ll pay for it with your monthly mortgage payments, your closing costs, or both. While no one likes paying extra, mortgage insurance is actually pretty useful. If you don’t have a lot of cash for a down payment it can help you land a loan — and the dream home you otherwise may not have been able to buy.
What are the different types of mortgage insurance?
There are a few different types of mortgage insurance. Two you should know about are private mortgage insurance (PMI) and mortgage insurance premium (MIP). There are also other types of mortgage insurance that differ from PMI and MIP — your lender should be able to tell you which you might need.
Private mortgage insurance (PMI) is for borrowers with a conventional mortgage loan and a down payment of less than 20 percent of the home’s value.
The cost of PMI depends on the length and amount of your loan, your credit score and your down payment. Annual PMI rates vary based on your down payment, credit score and other factors.
A common way to pay for PMI is through your monthly payment to your lender. Typically, you’ll pay little to no upfront PMI costs at closing with this approach. There’s also an option to pay for PMI with a one-time lump sum at closing, or do a combination of up-front and monthly payments.
Don’t worry, PMI may not be forever. You may be able to cancel your PMI once you’ve paid off 20 percent of your home. It’s also possible to get rid of PMI by refinancing your home, but make sure to take closing costs into account.
Tip: Some lenders offer conventional loans with a small down payment and no PMI. But keep in mind that these loans usually come with higher interest rates.
Related: How to get a mortgage step-by-step
Mortgage insurance premium (MIP) is required for all Federal Housing Administration (FHA) loans. There are two parts to MIP: an upfront fee you pay at closing and a fee that you pay monthly, usually as part of your mortgage payment.
The upfront fee for MIP is currently 1.75 percent of the loan amount. You can pay that in cash, or you can roll this cost into your loan. The rate of your monthly fee varies slightly depending on your loan terms and down payment.
Unlike PMI, you might have to continue paying MIP for the life of your mortgage. To get rid of MIP, you would typically need to refinance your mortgage to a conventional loan.
Related: How much are closing costs?
The bottom line
It’s never fun to tack on extra costs when you’re buying or refinancing a home. But mortgage insurance can be really helpful if you don’t have a ton saved for a down payment or haven’t built up a lot of equity. Your mortgage banker should be able to help you figure out if you’ll need mortgage insurance and which type fits your situation.