Understanding Mortgage Insurance: When Is It Required?

What Is Mortgage Insurance?

Mortgage insurance protects lenders in case a borrower defaults on their loan. It helps make lending more accessible for people who might not have a large down payment but still want to buy a home.

There are a few types of mortgage insurance based on the type of loan you're taking out:

• Private Mortgage Insurance (PMI): Required for conventional loans when the borrower’s down payment is less than 20%.
• FHA Mortgage Insurance (MIP): Required for Federal Housing Administration (FHA) loans, which are geared toward lower-income or first-time buyers.
• VA Funding Fee: For loans backed by the Department of Veterans Affairs (VA), which doesn’t technically require mortgage insurance but includes a funding fee.
• USDA Mortgage Insurance: For loans backed by the U.S. Department of Agriculture (USDA) for rural property buyers.

When Is Mortgage Insurance Required?

1. Conventional Loans (Private Mortgage Insurance - PMI)

If you're taking out a conventional loan (a loan not backed by the government) and your down payment is less than 20%, you’ll likely be required to pay Private Mortgage Insurance (PMI). PMI protects the lender if you default on the loan, as they are taking on more risk with a lower down payment.

The cost of PMI depends on factors like:

• The size of your down payment
• Your credit score
• The loan amount

PMI can usually be canceled once your loan balance reaches 78% of the home's original value (which is when you’ve built up 22% equity in your home). If you have a 20% or greater down payment, PMI is generally not required.

2. FHA Loans (FHA Mortgage Insurance - MIP)

FHA loans are designed for borrowers with lower credit scores or smaller down payments. When you take out an FHA loan, you’ll pay FHA mortgage insurance premiums (MIP). FHA MIP includes both an upfront premium (which can be rolled into the loan) and an annual premium divided into monthly payments.

Unlike PMI, FHA mortgage insurance premiums cannot be canceled. If your down payment is less than 10%, you’ll be required to pay MIP for the life of the loan. If your down payment is 10% or more, you’ll pay MIP for 11 years.

3. VA Loans (VA Funding Fee)

VA loans are available to active-duty military members, veterans, and their families. While VA loans don’t require mortgage insurance, they do have a VA funding fee. This fee is typically lower than PMI and is used to help fund the VA loan program. It can be rolled into the loan amount.

The VA funding fee depends on several factors:

• Whether it’s your first or subsequent use of the VA loan
• The size of your down payment (a higher down payment means a lower fee)

VA loans are one of the most affordable mortgage options because of the lack of mortgage insurance.

4. USDA Loans (USDA Mortgage Insurance)

USDA loans are designed for homebuyers in rural and suburban areas who meet certain income requirements. While USDA loans don’t require a down payment, they do include two types of mortgage insurance:

• Upfront Guarantee Fee: This fee is similar to PMI and can be rolled into the loan.
• Annual Fee: This is an ongoing fee added to your monthly payments. It’s typically lower than PMI.

These fees are intended to help make USDA loans more affordable for rural buyers while ensuring the program remains sustainable.

How to Avoid Mortgage Insurance

While mortgage insurance helps many homebuyers with small down payments, some borrowers prefer to avoid it. Here are some ways to do that:

1. Put Down 20% or More

If you can afford a 20% down payment, mortgage insurance is usually not required for conventional loans. This means you’ll have lower monthly payments, as you won’t have to pay for PMI. For FHA loans, the upfront mortgage insurance premium can still be required, but you won’t have to pay annual premiums.

2. Consider a Piggyback Loan

A piggyback loan involves taking out a second mortgage alongside your primary mortgage. For example, you could take out a 80% first mortgage, a 10% second mortgage, and put down 10% as a down payment. This structure allows you to avoid PMI on the first mortgage because the second mortgage covers part of the total loan.

3. Refinance Once You Reach 20% Equity

If you’ve already paid off enough of your mortgage to have 20% equity in your home, you can refinance your mortgage to remove PMI. This can save you money over time as you no longer have to pay for mortgage insurance.

Mortgage insurance can make homeownership more accessible, but it’s important to understand when it’s required and how it impacts your monthly payments. Whether you’re taking out a conventional loan with PMI, an FHA loan with MIP, or a USDA loan with mortgage insurance, knowing your options can help you navigate the homebuying process.

At My Easy Mortgage, we’re here to help you explore the best loan options for your needs, including ways to minimize or avoid mortgage insurance. If you have questions or are ready to start the mortgage process, contact us today!

Authors: Sam Wax, NMLS #336024

About the Author: Sam Wax is a licensed mortgage advisor with My Easy Mortgage, specializing in helping clients navigate the financial decisions around homeownership. With extensive knowledge of the mortgage industry, Sam provides personalized advice to guide clients toward the right choice. Connect with Sam and the team at My Easy Mortgage to explore the best path for your future.