What Is Mortgage Insurance and Do You Need It?

When you want to buy or refinance a home, you may be required to pay for mortgage insurance as part of your monthly payment. Whether or not you need to do this depends on the type of loan you want, how much you put down, and other factors we’ll discuss in this article. Knowing how mortgage insurance works can help you compare loan options and better understand the costs involved in homeownership.

What Is Mortgage Insurance on a Home Loan?

Mortgage insurance is a special insurance that protects your lender in case you default on your mortgage loan. It’s typically required when your down payment is less than 20%, since lower upfront equity is considered riskier to lenders. 

Mortgage insurance helps make homeownership more accessible by allowing you to qualify for a home loan with less money down.

How Does Mortgage Insurance Work?

Mortgage insurance protects the lender—not you as the borrower—if you don’t make your mortgage payments. Because low-down-payment loans are considered higher risk, lenders require mortgage insurance to reduce potential losses.

While the process will vary for conventional loans versus FHA loans, here’s how it typically works: 

1. The borrower pays an upfront premium, monthly premiums, or both depending on their loan type and policy. 
2. Premiums do not go to the lender, but instead to a private mortgage insurance company (for conventional loans) or HUD’s FHA Mutual Mortgage Insurance Fund (for FHA loans). 
3. If the borrower defaults on their loan, the lender can follow the appropriate claims process to recover a portion of the loan amount. 
4. The insurer can reimburse the lender for a portion of their loss based on policy limits and the claim. For example, if a policy covers 25% of the original loan amount, the insurer may reimburse the lender for the full 25% or less, depending on the situation and terms. 

The cost of mortgage insurance is an added expense that will increase your monthly costs, but may make it possible to buy a home sooner, even if you don’t have a lot of cash for the down payment.

Types of Mortgage Insurance

The two main types of mortgage insurance are private mortgage insurance (PMI), which is for conventional loans, and Mortgage Insurance Premiums (MIP), which are for FHA loans. USDA and VA loans often have a guarantee fee and funding fee instead. Here’s how they compare:

Private Mortgage Insurance (PMI) for Conventional Loans

Private mortgage insurance (PMI) is required on many conventional loans when your down payment is less than 20%. PMI helps protect the lender if you stop making your mortgage payments, but it can be removed in time or once you've built enough equity.

• When it’s required: If you make a down payment of less than 20%, you’ll have to pay for private mortgage insurance (PMI) when you buy a house with a conventional loan. If you make a down payment of 20% or more, you don’t need to pay for PMI.
• Cost: The cost will depend on your credit score, loan amount, and down payment, but it’s typically between 0.5% and 2% of your mortgage loan amount per year. 
• Ability to cancel: Once your home’s equity reaches 20%, you can often request to have the PMI canceled. Lenders are generally required to automatically remove PMI when the principle balance on your mortgage is scheduled to reach 78% of the home’s original value, as long as you're current on your payments.
• Refinancing: When you’re refinancing your conventional loan or refinancing into a conventional loan, you won’t need to pay for PMI if your equity is 20% or more.

Because PMI on conventional loans isn't permanent, many borrowers view it as a temporary cost that makes buying a home possible without waiting to save up for a 20% down payment.

FHA Loan Mortgage Insurance Premium (MIP)

Federal Housing Administration (FHA) loans don’t require PMI based on the down payment amount like conventional loans. Instead, FHA loans always include two types of mortgage insurance: an upfront mortgage insurance premium (UFMIP) paid at closing and a monthly insurance premium (MIP).

• When it’s required: Unlike PMI, FHA mortgage insuranceis required on nearly all FHA purchase and refinance loans, regardless of the size of your down payment.
• Cost: The upfront fee is typically about 1.75% of the loan amount. The annual MIP generally ranges between 0.15% and 0.75% of the loan amount, depending on your loan term, loan amount, and down payment.
• Ability to cancel: Unlike PMI, FHA mortgage insurance can't always be canceled. If your down payment is less than 10%, you’ll need to pay MIP for the life of the loan.  Borrowers who put 10% down with their FHA loan will see MIP drop automatically after 11 years.
• Refinancing: You’ll also need to pay upfront and monthly insurance premiums when you refinance an FHA loan. If you’ve received your current FHA loan within the past three years, you may be eligible for a refund on a portion of your previous UFMIP when you refinance.

Although MIP can increase your borrowing costs, FHA loans remain a popular option because they have lower down payment requirements and more flexible qualification standards than many conventional loans do.

Other Government-Backed Mortgage Fees

USDA and VA loans don’t require mortgage insurance but do have other related costs to consider.

• USDA guarantee fee: USDA loans don't use traditional mortgage insurance. Instead, they charge guarantee fees that help offset the cost of the USDA backing while allowing eligible borrowers to purchase and refinance homes with little or no down payment. The upfront guarantee fee is currently 1% of the initial loan amount, while the annual fee is typically 0.35% of the average unpaid principal balance. 
• VA funding fee: VA loans don’t require monthly mortgage insurance, even if you make no down payment. Instead, most eligible borrowers pay a one-time funding fee that helps keep the loan program running. Some disabled veterans and surviving spouses may qualify for an exemption from this fee. The fee ranges from 1.25% to 3.3% and is determined by your down payment amount and if you’ve used a VA loan before.

If you’re refinancing your VA loan into a lower rate through a VA Interest Rate Reduction Refinance Loan (IRRRL), also known as a VA streamline refinance, you’ll typically need to pay the VA funding fee again. However, this fee is just 0.5% of the loan amount, and you can often add it to your new loan balance, rather than paying it in cash at closing.