Mortgage insurance is required by various lenders under certain circumstances. You might think that your mortgage will be paid off if something should happen to you, leaving your family with a mortgage-free home, if you have such a policy, Unfortunately, this isn't the case. Mortgage protection insurance will pay off your mortgage for your family in the event of your death, but mortgage insurance is something else entirely. This type of policy protects your lender, not you.
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What Is Mortgage Insurance?
If you don't make your mortgage payments and the lender must foreclose, the insurance company will pay off your loan – but your lender is the beneficiary. Lenders routinely require these policies when a homebuyer makes less than a 20 percent down payment. The theory is that you don't have much of a financial stake in your property if you don't pony up a respectable amount of your own money toward its purchase. Fair or not, a skimpy down payment brands you as more of a risk for default.
You must pay the premiums, but don't count on shopping around for the best rates and selecting your own insurance company. Most lenders work with one or more insurers on a regular basis, although you can sometimes request one of the companies on your lender's short list over another.
What Is Private Mortgage Insurance Vs. Mortgage Insurance
Different rules and requirements exist under the umbrella of "mortgage insurance" and they're established by the type of mortgage you're taking out.
Conventional loans are covered by private mortgage insurance or PMI. As the name suggests, these policies are issued by private companies. But if you take out an FHA loan, the Federal Housing Authority acts as the mortgage insurance company – and the FHA requires mortgage insurance for all its loans regardless of down payment. The FHA is also the beneficiary of the policy, not your lender, because it has to pay your lender if you don't.
The U.S. Department of Agriculture and the Department of Veterans Affairs have their own mortgage programs and fees as well, similar to the FHA.
The Real Cost of Mortgage Insurance
So how much is all this going to cost? Enough that you might want to wait to buy a home until you've saved up 20 percent of the purchase price. It might also make you think long and hard about whether you really want to take out an FHA loan.
PMI rates vary depending on your credit score and how much money you're putting down. They generally run anywhere from .3 percent to 1.5 percent of your loan amount – the more money you put down and the better your credit, the less you'll pay. The median listing price of U.S. homes is in excess of $250,000 as of 2018, so your premiums could easily be more than $200 a month. If your credit score is pretty good, you'll generally pay less in the way of premiums than if you had taken an FHA-backed loan, however. This is particularly the case if your home is likely to appreciate in value steadily over time.
PMI is payable as part of your regular mortgage payment. It's typically included in that payment and your lender will then pay the premium each month on your behalf. Your lender doesn't want to take the chance that the policy will lapse if you don't make the payment. You generally don't have to pay much, if anything, toward the insurance at closing – although you can if you want to.
You won't catch a break on FHA mortgage insurance if your credit is good, but you won't pay that much more if you put down less than 5 percent on your loan, either. As of 2017, FHA mortgage insurance costs 1.75 percent of your loan, if you pay it all upfront at closing.
The FHA does require an upfront payment at closing in addition to monthly premiums, but it will allow you to roll the upfront payment into your mortgage balance so you don't have to come up with cash out of pocket. The same rule applies to USDA loans.
Finally, if you take out a VA loan, you won't have to pay ongoing premiums but you'll have to pay a "funding fee" at the time of closing. How much depends on several factors, including the nature of your military service and the amount of your down payment.
PMI Pros and Cons
Whether paying PMI might actually be a good thing is something of a moot question – it's not an elective option but rather a requirement. That said, paying the premiums can let you purchase a home sooner rather than later, or even at all if you think it's unlikely that you'll ever be able to save up 20 percent down. The 20 percent benchmark can be expected to increase in actual dollars and cents over time. The National Association of Realtors has indicated that home prices steadily increase at the rate of about 6 percent a year.
And here's another perk: If life strikes you a financial blow and you can't make your mortgage payments for a while, some PMI companies will allow you to make a partial claim. The mortgage company will make a few mortgage payments for you, which is preferable to paying the entire mortgage balance if you defaulted on the loan.
The request must be made through your lender. You must generally be suffering only temporary woes due to an event that was beyond your control. A partial claim works like a loan. You must pay the money back, although usually not with interest. You can also sometimes elect to purchase additional job loss coverage.
You're not necessarily committed to paying PMI for the entire life of your loan. Most private insurers and lenders allow you to cancel your policy when your equity in your property exceeds 20 percent. The policy won't cancel automatically until your equity reaches 22 percent.
The FHA does require that you pay the premiums over the life of your loan, however. Your only other option might be to refinance. This has been the case since 2013. Some isolated exceptions exist, but at a minimum you'll be paying those premiums for 11 years.