Most home shoppers know they’ll need to purchase a homeowners insurance policy before they can officially close on a mortgage—but what about mortgage insurance?
What is mortgage insurance and how does mortgage insurance work? We’ll cover the details here, including how long do you pay mortgage insurance.
What is mortgage insurance?
Mortgage insurance protects the lender in the event you, the borrower, fall behind on mortgage payments or default altogether. If you stop making payments, the lender can file an insurance claim for funds to help cover the missing mortgage payments.
When is mortgage insurance required?
It depends on the type of mortgage. Let’s say you’re taking out a conventional mortgage, meaning your loan isn’t part of a specific government program (although it could be a conforming loan, which means that it meets criteria to be sold to a government-sponsored enterprise such as Fannie Mae or Freddie Mac). Generally, if your down payment is less than 20% of the home’s price, you’ll have to pay for private mortgage insurance. From a lender’s perspective, a small down payment makes the loan riskier, so the lender offsets part of that risk by requiring private mortgage insurance.
If you have a Federal Housing Administration (FHA) loan, mortgage insurance is required regardless of the size of your down payment.
How does mortgage insurance work?
If you’re required to pay private mortgage insurance, it usually becomes a portion of your monthly mortgage payment, along with principal, interest, taxes and homeowners insurance.
The amount you’ll pay for private mortgage insurance—the premium—depends on your credit score, your down payment and the particular insurer. Premiums often range from $30 to $70 per month for every $100,000 borrowed. FHA loans require an upfront mortgage insurance premium in addition to monthly premium payments.
For example: If you’re buying a $400,000 home with a fixed-rate mortgage and making a 10% down payment of $40,000, your loan-to-value ratio (LTV) is 90% and the mortgage amount is $360,000. Let’s say the lender requires a 90% LTV mortgage to have 25% insurance coverage. If a claim is filed, the insurer is responsible for paying 25% of the outstanding loan balance (up to $90,000) and the lender is at risk for the remainder of the loan amount (up to $270,000).
We see how mortgage insurance can benefit the lender—but it can also benefit the borrower: Mortgage insurance enables borrowers who can’t afford a 20% down payment to still buy a home, albeit at a monthly cost.
How long do you pay mortgage insurance?
For conventional loans, most borrowers will have to pay a private mortgage insurance premium until the LTV ratio reaches 80%, at which point the insurance can usually be cancelled. According to the Consumer Finance Protection Bureau, to cancel your private mortgage insurance, you must request cancellation in writing, be current on your payments and have no other liens on your home (like a second mortgage). Since removing mortgage insurance premiums can lower your monthly mortgage payment, be sure to contact your lender when your LTV reaches 80%.
Once your LTV reaches 78%, your loan servicer must cancel private mortgage insurance (or allow it to “fall off”) if you’re current on your payments.
For most FHA loans, you’ll have to pay a mortgage insurance premium as long as you have the loan; the only way to remove the insurance is to pay off the loan or refinance into a conventional loan.
If you’re currently a homeowner with mortgage insurance, rising home values may mean you’ve already hit the 80% LTV and can get rid of your mortgage insurance by refinancing. It only takes 3 minutes, and won’t affect your credit score, to see how much you could save with Clara.