When you need it, and Why
Typically, when borrowers make a down payment of less than 20 percent of the purchase price of the home, or when they’re choosing a government backed loan, they will need to pay for mortgage insurance. Mortgage insurance lowers the risk to the lender of making a loan to you, so you can qualify for a loan that you might not otherwise be able to get. But, it also increases the cost of your loan.
If you are required to pay mortgage insurance, it will be included in your total monthly payment that you make to your lender, your costs at closing, or both.
Mortgage insurance, no matter what kind, protects the lender — not you — in the event that you fall behind on your payments. If you fall behind, your credit score will suffer and you can lose your home through foreclosure.
There are several loan options available to borrowers with low down payments. Depending on what kind of loan you get, you’ll pay for mortgage insurance in different ways:
Private Mortgage Insurance
If you get a conventional loan with a down payment of less than 20%, your lender will arrange for mortgage insurance with a private company. Private mortgage insurance (PMI) fees vary, depending on the size of the down payment and your credit score, from around 0.3% to about 1.5% of the original loan amount per year. Most PMI is paid monthly, with little or no initial payment required at closing.
Your lender must automatically cancel PMI when your outstanding loan balance drops to 78% of the home’s original value, but depending on the size of your initial down payment, it could take several years before your reach this threshold.
FHA Mortgage Insurance
If you get an FHA loan, your mortgage insurance premiums are paid to the Federal Housing Administration (FHA). FHA mortgage insurance is required for all FHA loans. It costs the same no matter your credit score, with only a slight increase in price for down payments less than five percent. FHA mortgage insurance includes both an upfront cost, paid as part of your closing costs, and a monthly cost, included in your monthly payment.
You’re also allowed to roll the upfront fee into your mortgage instead of paying it out of pocket, but if you do this, your loan amount and the overall cost of your loan will increase. Recent FHA-insured loans require payment of mortgage insurance premiums for the life of the loan, so FHA mortgage insurance premiums can’t be canceled; instead, you’d have to refinance the loan.
USDA Mortgage Insurance
If you get a U.S. Department of Agriculture (USDA) loan, the program is similar to the FHA’s, but usually cheaper. You’ll pay for the insurance both at closing and as part of your monthly payment. Like with FHA loans, you can roll the upfront portion of the insurance premium into your mortgage instead of paying it out of pocket, but doing so increases both your loan amount and monthly payment.
VA Funding Fee
If you get a VA loan, the Department of Veterans’ Affairs (VA) guarantee replaces mortgage insurance, but functions similarly. With VA loans, there is no monthly mortgage insurance premium. However, you will pay an upfront “funding fee.” The amount of that fee varies based on your type of military service, your down payment amount, your disability status, whether you’re buying a home or refinancing, and whether this is your first VA loan, or you’ve had a VA loan previously.
Like with FHA and USDA loans, you can roll the upfront fee into your mortgage instead of paying it out of pocket, but doing so increases both your loan amount and your overall costs.