Understanding Mortgage Insurance: What You Need to Know

If you take out a conventional home loan with less than a 20 percent down payment, lenders often require that you purchase private mortgage insurance (PMI) as a condition of qualifying for the loan. Similarly, the federal government mandates that borrowers with a home loan backed by the Federal Housing Administration (an FHA loan) pay what is referred to as a mortgage insurance premium (MIP).

These types of insurance policies are intended to reduce the risk to the lender in case the borrower fails to make payments — they do not protect the homeowner. However, mortgage insurance can enable a buyer to get a home they may not otherwise be able to afford, and often at a more competitive interest rate. Especially in a high-cost housing market, mortgage insurance can lower the barrier to home ownership and allow a renter to buy sooner than would otherwise be feasible.

On the other hand, purchasing mortgage insurance will increase the monthly costs of home ownership — at least initially. When shopping for a home loan, here are key facts and considerations about these policies to help ensure that you make an informed decision:

Why might a lender require that you take out mortgage insurance for a home loan?

All else being equal, a buyer who makes a larger down payment presents a lower level of risk to a lender. Essentially, those who invest more of their own money at the outset have greater financial motivation to meet the contractual obligations of a mortgage. A bigger down payment means that the buyer has more to lose by defaulting on the loan. 

But the stakes aren’t as high for homebuyers who invest less of their own money upfront. With a less sizeable down payment, a buyer could be more inclined to stop making payments if finances become strained or the value of the home takes a dip in a down market. 

Private mortgage insurance (PMI) can offset the risk that the lender assumes when providing a higher-risk loan. If a home must be sold through foreclosure because the owner failed to make payments and the sale does not cover the mortgage balance, the insurance proceeds will allow the financial institution to recoup a portion of the loss.

For those who have very limited savings, a lower credit score, or limited credit history, an FHA loan can be a viable option for buying a home. These mortgages generally have more lenient credit qualifications compared to conventional loans, and they allow for down payments as low as 3.5 percent of the home’s purchase price. But one downside of an FHA loan is an upfront insurance payment (which can also be rolled into the mortgage) in addition to monthly insurance premiums.

How much can you expect to pay for mortgage insurance?

The rate for private mortgage insurance (PMI) on a conventional loan is calculated as a percentage of your loan amount on an annual basis. Zillow puts the typical rate for PMI between 0.58% and 1.85% of the loan amount. However, this rate can be higher, depending on factors such as your down payment, the loan amount, your credit score, the property’s value, and other criteria. Homebuyers with larger loans and lower credit scores will generally receive higher rates because they are perceived as higher-risk borrowers. 

The average cost of PMI ranges from $30 to $70 for every $100,000 borrowed. In many cases, this will add up to several hundred dollars per month. You can calculate monthly PMI payments by multiplying your loan amount by the PMI rate and then dividing this number by twelve. With some PMI policies, your premiums can be reduced each year as you pay down the principal on your mortgage.

If you take out an FHA loan which is guaranteed by the government and issued by an approved lender, you must pay a qualified mortgage insurance premium (MIP) regardless of the size of your down payment. You cannot avoid paying mortgage insurance on an FHA loan by making a down payment of 20% or more. 

The FHA mortgage insurance premium (MIP) includes an upfront cost at closing of 1.75% of the loan’s value and a recurring annual fee paid monthly as part of the mortgage. This monthly fee is usually 0.55% of the loan amount divided into 12 monthly installments. As Zillow explains, the MIP for a mortgage of $300,000 would be an upfront fee of $5,250 as well as an annual premium of $1,650, which would be divided into 12 monthly payments of $137.50.

How does mortgage insurance work?

In most cases, PMI for a conventional loan is added to your mortgage payment each month — you’ll see it as a line item on your statement. Alternatively, you might choose to pay PMI in a lump sum that is included in your closing costs, or as a spit premium in which the costs are divided between up front and monthly payments. Some mortgage products also offer lender-paid mortgage insurance (LPMI), in which the lender covers the cost of your mortgage insurance, and in exchange, you pay a slightly higher interest rate or higher fees.

How long do you have to pay for mortgage insurance?

Provided that you have not taken out a high-risk loan, the Homeowner’s Protection Act mandates that your mortgage servicer cancel your PMI payments once your mortgage balance is reduced to 78% of the home’s original value, or when the mortgage hits the halfway point of the loan term (e.g., after 15 years of a 30-year loan). By law, the provider must drop the policy at this point without receiving a request from you to cancel it. However, it’s advisable to check that your policy has been cancelled once you’re met this 78 percent threshold to ensure that the provider has complied and there hasn’t been an oversight. 

If you take out an FHA-backed loan, you will continue to pay your mortgage insurance premiums throughout the life of the loan if you make a down payment of less than 10%. With a down payment of 10% or more, you’ll pay these premiums for 11 years. For some, the only way to eliminate the FHA mortgage insurance premium (MIP) is to refinance into another type of loan.

Is it possible to get PMI removed early to save money and lower your monthly payments?

You can request that PMI be cancelled when your mortgage balance drops to 80% of the original home value (either the price you paid for the property or the appraised value when you bought it — whichever is lower). However, if your loan is considered high risk (e.g., you have below average credit), you may need to continue to pay the premiums until you have acquired more equity. Find details on how to eliminate PMI at the Consumer Financial Protection Bureau.

What are the major reasons to purchase mortgage insurance?

Saving for the down payment is continually cited as the biggest obstacle renters face to buying a home. And this is especially the case if you live in a high-priced, competitive market in which the standard 20 percent down payment equates to roughly $260,000 for the median-priced home. 

Paying for mortgage insurance enables home buyers to take advantage of various loan programs with low down payment options, which can be the critical difference that makes home ownership accessible. But even those who have the funds to make a 20 percent down payment may decide to buy a home with less money down to avoid shelling out so much cash at one time. 

While purchasing mortgage insurance means spending more on monthly costs (at least for a while), it could potentially be the more lucrative option in the long run. If you wait until you’re ready to put 20 percent down, you may lose out on valuable opportunities to build equity in your property and for it to increase in value. In a fast-growing real estate market, you may find that getting the home you want at an affordable price gets more difficult over time.

Buying a home is a rewarding life goal that can help create wealth and future financial stability, and there are various financing programs today that can make it more attainable. When you’re ready to explore your options, a great place to start is The Police Credit Union’s site. You’ll find a wealth of information and tools, and a wide range of loans to fit your budget and lifestyles goal. 

In addition, we’re proud to offer our members who are active-duty law enforcement buying their first home in California our H.E.R.O. Loan, a zero-down payment loan with no PMI requirement and loan limits up to $1,000,000.*. What’s more, this loan is eligible for our “End of Watch Debt Forgiveness Benefit,” which provides peace of mind and a financial safety net for the families of qualified fallen officers, at no cost to the member.

Program available to first-time homebuying members of the credit union that are an active full-time sworn peace officer or reserve peace officer employed by a federal, state, county or municipal agency. Program consists of a fixed or variable rate 1st and a fixed 2nd mortgage. Property must be located in California, and be owner occupied. First time home buyers may not have had ownership in a principal residence during the preceding 3 years. All loans subject to credit approval, documented income and reserve requirements. There is a non-refundable application fee of $95 for this program that will be credited back at closing. Additional terms, conditions and restrictions apply. Program is subject to change or cancellation without notice. Contact your TPCU Loan Officer for terms, rates and full details. Federally insured by the NCUA. Equal Housing Opportunity. NMLS #: 409710

*Maximum loan limit may go up to $2,000,000 for qualified applicants, amount is for the total combined amount of the first and second mortgages.

Whether you’re a first-time homebuyer, looking to refinance, or interested in learning more about home loans, we’re committed to helping you through every stage of the process.

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