What is Mortgage Insurance?

Have you heard the term mortgage insurance, MIP, or PMI during the buying or mortgage process? If you are planning to put down less than 20% when you buy a home, it is likely someone has mentioned mortgage insurance to you. So, what is mortgage insurance?

Mortgage insurance is an insurance policy that protects the lender. When a buyer puts less than 20% down on a home, the lender providing the loan is taking on greater risk. (A buyer with more than 20% down is less likely to default on payments because they have more of their own money at stake.) To mitigate this risk, the buyer pays a monthly premium for a mortgage insurance policy that reduces the lender’s risk. If a buyer defaults on their mortgage payments and the bank is forced to foreclose, premiums that have been paid offset the loss.

If you purchase a home using a conventional loan, the lender will go through a private insurance company and you will be paying private mortgage insurance (PMI.) PMI rates vary based upon down payment and credit score but are typically lower than mortgage insurance rates with the FHA loan.

Speaking of the FHA loan, if you use this product to purchase a home, you will pay mortgage insurance to the Federal Housing Administration (FHA) and it is called a mortgage insurance premium (MIP.) MIP is the same rate regardless of credit score but will increase if you put less than 5% down. MIP is comprised of both an upfront fee and a monthly premium. If you can’t pay the upfront fee with your closing costs, it can be rolled into the mortgage, but this will cause an increase in the overall cost of your loan.

Buyers using the VA loan do not have to worry about mortgage insurance. The VA loan is backed by the Department of Veteran’s Affairs, and up to 20% of the loan is guaranteed. Rather than needing insurance to minimize a lender’s risk, the VA guarantees they will reimburse up to 20% of the loan if a buyer defaults on their payments. Only qualified veterans and their spouses qualify for the VA loan. The VA loan can be used more than once, but you can never use more than 100% of your entitlement. Currently, the VA entitlement is 20% of a loan $484,350. While this loan does not have mortgage insurance, there is an upfront funding fee.

While you can avoid mortgage insurance by putting 20% down on a home, you should consider the risk of higher interest rates down the road. Put simply, it may actually cheaper to buy today with 5% or 10% down plus mortgage insurance than to buy in the future with 20% down at higher interest rates.

If you are interested in learning more about your financing options and what might make the most financial sense for you, contact me anytime! We’ll grab a cup of coffee and discuss your options. If you have questions right now, comment below!