Is Mortgage Insurance Required for All Home Loans?
Not all homebuyers can afford a large down payment up front. In fact, the average down payment by first-time homeowners was seven percent in 2020. For all homebuyers in 2020, the average down payment was 12 percent. So, in the very common scenario where your down payment is less than the “golden standard” of 20 percent, purchasing mortgage insurance is required to provide financial protection for the lender.
Purchasing some form of mortgage insurance, whether it’s private mortgage insurance ( PMI ) or paying an additional mortgage insurance premium ( MIP), is typically required when you finance more than 80 percent of your home. The type of mortgage insurance may vary, depending on the type of loan you get.
First, there’s the conventional loan that allows you the greatest amount of flexibility on your home purchase. Many lenders offer conventional loans with low down payment requirements with the requirement of paying for PMI. In most cases, the monthly PMI premium is included in your mortgage payment.
Once you have over 20 percent equity in your home, you can request PMI cancellation. Home equity is calculated by taking the current market value of your home and subtracting any liens (debts) attached to that home. Some homeowners may choose to make early payments on their mortgage to reach 20 percent home equity sooner to stop paying PMI and save money on the entirety of their mortgage.
These loans are insured by the Federal Housing Administration. Homebuyers who get an FHA loan may see benefits such as lower down payments (as low as 3.5 percent in some cases), lower closing costs, and easier credit qualifications. Instead of a PMI, FHA loans require you to pay an up-front and monthly MIP.
With most FHA loans, you will pay an up-front MIP that is equal to 1.75 percent of the total loan amount. You will also be required to pay an annual MIP that ranges between 0.45 and 1.05 percent of the average outstanding balance of your loan for that year. The annual MIP can be paid in monthly installments.
Although FHA loans are easier to qualify for and come with nice benefits, you will have to pay an MIP for the entire life of the loan if your down payment was less than 10 percent. If your down payment was greater than 10 percent, then you can ask to cancel MIP after making mortgage payments for 11 years.