Do You Have to Have Mortgage Insurance?
Mortgage insurance is something millions of homeowners pay for each year. However, this type of insurance does not protect the homeowner.
Mortgage insurance is designed to protect the lender. If the homeowner were to default on the loan, the mortgage insurance would pay off the loan to the lender, but the homeowner would still lose their home.
So, is mortgage insurance a requirement? Believe it or not, mortgage insurance is only required for specific types of mortgages.
What is Mortgage Insurance?
If you don’t have a lot of money saved up to put towards a home, you can still secure a mortgage. In fact, with an FHA mortgage, you can qualify by putting down 3.5% of the home's value in the form of a down payment, so long as you meet the current requirements.
However, the less money you put down on a home, the riskier lenders tend to consider you to be. To make a lender comfortable with lending you money, they may require you to purchase mortgage insurance. This insurance is often referred to as private mortgage insurance, or PMI.
Even though you’ll be paying for mortgage insurance on a monthly basis, you are not the beneficiary. You’ll be paying this expense on behalf of the bank, making the bank the beneficiary.
If you default on your loan, you will still lose your house. However, the bank will receive the money they are due thanks to the mortgage insurance.
How Much Does Mortgage Insurance Cost?
Unfortunately, there is not a one-size-fits-all approach to mortgage insurance. Your monthly mortgage insurance payment will depend on how much money you put down on your home and what type of mortgage you originally used to finance your home.
For example, FHA loans have a different PMI rate compared to conventional mortgages. On average, mortgage insurance will cost you anywhere from 0.35% to 2.25% of your loan amount.
Pros and Cons of Mortgage Insurance
Let’s review the pros and cons of mortgage insurance.
By paying mortgage insurance, a homeowner can likely purchase a home with a less substantial down payment. For example, saving up for a 20% down payment on a $300,000 home is difficult, whereas saving up for a 3.5% down payment on the same home is probably easier.
If there wasn’t mortgage insurance, banks would not likely be comfortable lending money to a homebuyer who just puts down a 3.5% down payment. In this way, mortgage insurance has helped people secure loans that they previously would not qualify for.
Mortgage insurance does not protect the homeowner, it protects the lender. Depending on the type of loan you purchased, mortgage insurance can be with you for the life of the loan.
This can add up to a great deal of money, and again, the homeowner does not get the protection. Mortgage insurance takes money out of your pocket each month, increasing the cost of owning a home.
Needless to say, most people would prefer to save $100-$200 per month, instead of paying for insurance that does not protect them.
Do Conventional Mortgage Loans Require Insurance?
Conventional mortgages do not always require mortgage insurance. In fact, you’ll just pay PMI on a conventional mortgage if your down payment isn’t at least 20%. If your down payment is less than 20%, you will be paying mortgage insurance on a conventional loan.
If you are financing via a conventional mortgage and do in fact need PMI, you can request the lender drops the PMI once you reach 20% equity in your home.
What About FHA Loans?
FHA loans require mortgage insurance. Generally speaking, an FHA loan is used in the following situations:
The homeowner does not have the best financial picture, such as a low credit score.
The home buyer does not have enough money to meet a conventional mortgage requirement.
The home buyer is a first time home buyer, and just starting out professionally.
FHA loans are guaranteed by the United States Government, therefore, they absolutely need mortgage insurance in case the homeowner defaults on their loan.
If you are in an FHA loan, you can always refinance to a conventional loan once you build equity in your home. By refinancing your mortgage you may be able to save quite a bit of money on mortgage insurance.
What About VA Loans?
VA loans do not require PMI. This is one of the greatest benefits of a VA loan. The government still backs VA loans, but as a thank you to our veterans, the government and lenders do not require the individual or family to carry mortgage insurance.
How to Avoid Paying for Mortgage Insurance
There are several ways to avoid paying for mortgage insurance. The most common options include:
- Be prepared to put down a down payment of 20% or more.
- Consider using a piggyback mortgage. This is more challenging to qualify for, but is essentially a second mortgage. Your first mortgage covers 80% of the home's value, the second mortgage covers 10% of the home's value, and you are required to put down 10%
- Refinance your home once you’ve hit 20% equity. Therefore your loan to value ratio will be 80/20 and mortgage insurance will no longer be required.
Know your Options
Without question, mortgage insurance has helped millions of people qualify for homes they otherwise would not be able to. However, beyond the initial qualification, mortgage insurance feels more like a financial drain than a benefit.
Remember, PMI does not protect the homeowner, but rather protects the bank if the homeowner defaults on their mortgage. PMI is a requirement for specific loans, but not all of them. Be sure to review all the various loan options available to you before deciding which loan is right for you.
This page last updated: May 13, 2022
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