Mortgage insurance isn’t necessarily a bad thing

If you put less than 20% down on a home, private mortgage insurance (PMI) is usually required. Many homebuyers try everything they can to avoid paying PMI. Why? Mortgage insurance, unlike homeowners insurance, protects the lender rather than the borrower.

However, there is another way to look at it. Mortgage insurance can help you get into a home much sooner. PMI may cost you more than $100 per month. However, you could start earning up to $20,000 per year in home equity. PMI is worthwhile for many people. It’s a ticket out of the rental market and into equity wealth.

Insuring a mortgage

Private mortgage insurance (PMI) protects mortgage lenders against defaulting borrowers. So it goes. Mortgage lenders typically lose about 20% of the home’s value if a borrower defaults on their loan. If you put down 20%, you are compensating the lender for the potential loss if your loan defaults and goes into foreclosure. If you put down less than 20%, the lender will most likely lose money in the event of a foreclosure.

In order to protect themselves, mortgage lenders charge insurance on conventional loans with less than a 20% down payment. It is the lender’s additional loss margin that mortgage insurance takes care of for them. Lenders will get a mortgage insurance check to cover their losses in the case of your loan default. That may appear to be a difficult situation. The advantage of mortgage insurance is that it allows you to get a head start on home ownership.

Many people would have to wait years without mortgage insurance to save up for a larger down payment before purchasing a home. While renting, they could have used that time to invest in their property and develop equity instead.

How much does mortgage insurance cost?

The cost of mortgage insurance (MI) varies depending on the loan program (see the table below). In general, mortgage insurance costs between 0.5 and 1.5 percent of the loan amount per year.

So, for a $250,000 loan, mortgage insurance would cost between $1,250 and $3,750 per year, or $100 and $315 per month.

Mortgage insurance premiums (MIP)

It’s worth noting that most loan types have two mortgage insurance rates: an annual rate and an initial rate or “fee.” The initial mortgage insurance fee is typically higher, but it is paid only once when the loan is closed. And both types of mortgage insurance differ depending on the loan program.

Mortgage insurance costs vary by loan type

The mortgage insurance rate varies depending on the loan type. So, even for the same loan size, mortgage insurance costs can vary greatly depending on whether you get a conventional, FHA, VA, or USDA loan.

How does mortgage insurance work?

Only the amount of the loan, not the home’s worth or purchase price, is taken into account when calculating mortgage insurance premiums. For instance, if your loan is $200,000 and your annual mortgage insurance is 1.0 percent, you would pay $2,000 in mortgage insurance that year. Because annual mortgage insurance is recalculated each year, your PMI cost will decrease as you pay off your loan.The mortgage insurance rate is pre-set for FHA, VA, and USDA loans. 

Conventional PMI mortgage insurance is calculated based on the amount of your down payment and your credit score. Mortgage insurance premiums are normally paid in 12 equal monthly payments. You simply pay it as part of your monthly mortgage payment.

Private mortgage insurance costs versus benefits

Today’s homeowners are amassing wealth at a rate seen only a few times in history.

The average homeowner in the United States earns $13,000 per year. Furthermore, home value appreciation is not a new phenomenon. According to the FHFA, home prices have risen by about 5% per year since 2012. And, since 2011, home values have risen in every quarter. That means that a renter who purchased the ‘average’ home four years ago has amassed more than $40,000 in home equity. Some have made significantly more — six figures in some cases.

What’s surprising, then, is “advice” that says you should only buy a home if you have a 20% down payment. Putting down 20% is less risky than making a small down payment, but it is also more expensive. Even staunch opponents of mortgage insurance find it difficult to argue with this fact: PMI payments, on average, provide a significant return on investment.

Make use of PMI as a tool for wealth creation

In the United States, home ownership is the primary means of accumulating wealth. Each monthly mortgage payment can be viewed as a future investment. Buying a house is not a quick way to get rich. Rather, it is a long-term investment that pays off gradually, even during cyclical downturns.

PMI with direct-to-buyer advantages

PMI benefits the buyer indirectly, but some mortgage insurance companies are now providing direct value to buyers as well. On top of its normal PMI coverage, Radian offers MortgageAssureSM. This program protects the buyer from job loss. In the event of a job loss during the first two years of the loan, the insurance will cover the borrower’s payments — up to $1,500 per month for six months. For home buyers who make a down payment of 3-5 percent on certain loan programs, the program is free.

This provides the homebuyer with peace of mind and is a compelling reason to investigate which PMI providers your lender works with rather than accepting the default PMI rates and providers assigned by the lender. Mortgage lenders frequently collaborate with three to five PMI providers. Most of the time, the lender will select your provider for you. The decision is frequently arbitrary or based on who the lender is used to working with. However, the borrower has a say in the matter. If you know of a PMI provider who provides a specific benefit, don’t be afraid to request it. The minor request could end up making a significant difference in the long run.

When will I be able to cancel PMI?

When your loan balance reaches 78 percent of the original purchase price of your home, your PMI should be automatically cancelled. However, you may be able to cancel PMI sooner if you contact your loan servicer when you reach the 80% threshold. Remember that these rules only apply to conventional loans. Subsidized loans, such as USDA and FHA mortgages, are handled differently.

Mortgage insurance premiums for FHA loans (MIP)

FHA loans, which are guaranteed by the Federal Housing Administration, necessitate their own type of mortgage insurance. This is referred to as the mortgage insurance premium, or MIP.

MIP charges two fees: one up front and one on an annual basis.

• The UFMIP (upfront mortgage insurance premium) is 1.75 percent of the loan amount. It can be paid at closing, but most home buyers include it in their loan balance.
• The annual mortgage insurance premium (MIP) is 0.85 percent of the loan amount, divided into 12 installments and paid monthly with the mortgage payment. Unless you put down at least 10%, this will be due for the life of the loan. In that case, the MIP payments would be terminated after 11 years.

Of course, a homeowner could refinance out of an FHA loan to avoid MIP payments. If the loan-to-value ratio of the home has dropped below 80%, refinancing into a conventional loan could help eliminate MIP later on.

USDA and Veterans Administration loans

USDA loans also have a one-time and ongoing mortgage insurance fee. USDA mortgage insurance rates, on the other hand, are slightly lower, with a 1% upfront fee and a 0.35 percent annual charge.

VA Loans, which are guaranteed by the federal Department of Veterans Affairs, do not require monthly mortgage insurance payments. The VA charges an upfront funding fee to help insure lenders, but there is no additional monthly charge for the borrower.

How do I know if PMI is appropriate for me?

Private mortgage insurance isn’t for everyone, but before dismissing it out of hand, home buyers should consider the potential returns.