Mortgage insurance isn’t a bad thing
Private mortgage insurance (PMI)
is usually required if you put less than 20% down
on a house.
Many homebuyers try to avoid PMI at all costs. Why? Because unlike homeowners insurance, mortgage insurance protects the lender rather than the borrower.
But there’s another way to look at
Mortgage insurance can put you in a house a lot sooner. You might pay more than $100 per month for PMI. But you could start earning upwards of $20,000 per year in home equity.
For many people, PMI is worth it. It’s a ticket out of renting and into equity wealth.
In this article (Skip to…)
PMI — private mortgage insurance —
is a type of insurance policy that protects mortgage lenders in case borrowers
default on their loans. Here’s how it works.
If a borrower defaults on their
home loan, it’s assumed the lender will lose about 20% of
the home’s sales price.
If you put down 20%, that
makes up for the lender’s potential loss if your loan defaults and goes into foreclosure. Put down less than 20%, and the
lender is likely to lose money in the event of a foreclosure.
That’s why mortgage lenders charge insurance on conventional
loans with less than 20% down.
Mortgage insurance covers that
extra loss margin for the lender. If you ever default on your loan, it’s the
lender that will receive a mortgage insurance check to cover its losses.
That might sound like a tough
deal. But the upside is, mortgage insurance gives you a fast track to home
Without mortgage insurance, many
people would have to wait years to save up for a bigger down payment before
buying a house.
Those are years they could have
spent investing in their home and building equity — rather than paying rent to
a landlord each month.
How much is
Mortgage insurance costs vary by loan program (see the table below). But in general, mortgage insurance is about 0.5-1.5% of the loan amount per year.
So for a $250,000 loan, mortgage insurance would cost around $1,250-$3,750 annually — or $100-315 per month.
Note that for most loan types, there are two mortgage insurance rates: an annual rate and an initial rate or “fee.”
The initial mortgage insurance fee is usually higher, but it’s only paid once when the loan closes. And both types of mortgage insurance vary by loan program.
|Conventional Loans||FHA Loans||USDA Loans||VA Loans|
|Initial Mortgage Insurance||n/a||“Upfront Mortgage Insurance Premium”||“Upfront Guarantee Fee”||“Funding Fee”|
|Annual Mortgage Insurance||“PMI Annual Premium”||“Mortgage Insurance Premium”||“Annual Fee”||n/a|
insurance rates are shown as a percentage of the loan amount
funding fee is 2.3% for first-time use, and 3.6% for subsequent uses
mortgage insurance by loan type
Each loan type has a different
mortgage insurance rate. So even for the exact same loan size, mortgage
insurance costs could be very different depending on whether you got a
conventional mortgage, FHA, VA, or USDA mortgage.
For example, say you buy a $300,000 home with 3.5 percent down*. Here’s how mortgage insurance costs would compare for the four major loan types:
|Conventional Loan||FHA Loan||USDA Loan||VA Loan|
|Initial Mortgage Insurance Cost||$0||$5,000||$2,900||$6,700|
|Annual Mortgage Insurance Cost (Paid Monthly)||$3,500||$2,500||$1,000||$0|
above example assumes a $300,000 home purchase with 3.5% down, and a 30-year
fixed interest rate of 3.75%. Your own rate and mortgage insurance costs will
*Annual mortgage insurance cost is calculated based on year 1 loan balance. Annual costs will go down each year as the loan balance is reduced
How is mortgage
Mortgage insurance is always
calculated as a percentage of the mortgage loan amount — not the home’s value or
For example: If your loan is
$200,000, and your annual mortgage insurance is 1.0%, you’d pay $2,000 for
mortgage insurance that year.
Since annual mortgage insurance is
re-calculated each year, your PMI cost will go down every year as you pay off
For FHA, VA, and USDA loans, the mortgage insurance rate is pre-set. It’s the same for every customer (see the table above).
For conventional loans, mortgage
insurance is calculated based on the customer’s application. Conventional PMI
mortgage insurance is calculated based on your down payment amount and credit
Typically, the ongoing annual premiums for mortgage insurance are spread across 12 monthly installments. You simply pay it each month as part of your regular mortgage payment.
mortgage insurance by credit score
The following chart compares cost differences
between the three major types of mortgage insurance, based on a $250,000 loan
amount, and varying credit levels.
|660 FICO Score||700 FICO Score||740 FICO Score|
|Conventional 5% Down||$295||$180||$120|
|Conventional 10% Down||$210||$125||$85|
|FHA 3.5% Down||$175||$175||$175|
|USDA 0% Down||$75||$75||$75|
benefit of private mortgage insurance
Today’s homeowners are building
wealth like few times in history.
According to the Federal Housing
Finance Agency (FHFA), home values in the third quarter of 2020 were up
more than 7% from the same period one year prior.
The typical U.S. homeowner is
earning $13,000 per year.
What’s more, home value
appreciation is nothing new. FHFA says home prices have increased by about 5%
per year since 2012. Home values have increased every quarter dating back to 2011.
That means a
renter who bought the ‘average’ home four years ago has gained more
than $40,000 in home equity to date. Some have earned much
more — six figures in some cases.
What’s surprising, then, is
“advice” saying you should buy a home only when you have a 20% down payment.
Putting 20% down is less risky than
making a small down payment, but
it’s also costly.
Even strong opponents of mortgage
insurance find it hard to argue against this fact: PMI payments, on
average, yield a huge return on investment.
PMI return on
Home buyers avoid PMI because they
feel it’s a waste of money.
In fact, some forego buying a home
because they don’t want to pay PMI premiums.
That could be a mistake. Data from
the housing market indicates that PMI yields a surprising return on investment.
Imagine you buy a house worth $233,000 with 5%
The PMI cost is $135 per month
according to mortgage insurance provider MGIC. But it’s not permanent. It drops
off after five years due to increasing home value and decreasing loan
Remember, you can cancel mortgage insurance on a
conventional loan when your mortgage balance falls to 80% of your home’s purchase
The homeowner’s snapshot at the
end of year 5 looks like this:
- Current value: $276,000
In five years, the home has
appreciated $43,000, and the final PMI cost is $8,100. That’s a 5-year return
on investment of 530%.
impossible to make that kind of return in the stock market, retirement account,
or another financial instrument.
PMI, then, can be viewed as an
investment — a very sound one — and not a waste of money.
Homeownership is the primary means
of wealth building in the U.S. Each monthly mortgage payment can be considered an investment
in the future.
Owning a home is no path to quick
riches. Rather, it’s an investment that pays off gradually over
time, even considering cyclical downturns.
Long-term housing data supports
According to the government
lending agency FHFA, home real estate values are up more than 140% since
1991. That means a home worth $100,000 in January 1991 is worth $240,000 today.
Over that time, inflation has
risen 75%, says the Bureau of Labor Statistics. A first-time home buyer in 1991
has beaten inflation, plus made an additional 65%
return on investment.
Inflation-adjusted return is a
tangible way to look at wealth increases, but there are non-tangibles, too.
For instance, a homeowner who
purchased a home in 1991 is likely near the end of their
30-year fixed mortgage. Soon, the homeowner will be mortgage-free. Their cost of
living will drop.
The owner holds a considerable
Yet, a person who chose to rent in
1991, and continued to do so, now pays ever-increasing rental prices.
Worse, it’s likely this person has
asset unless he or she has contributed to a
retirement account or other investment consistently over two or three decades.
Many have not been this forward-thinking.
A house is a forced savings
account. Housing expenses are required whether you rent or own. But when you
own, you deposit a small chunk toward your
future wealth each month.
So what does PMI have to do with this? It starts the wealth-building process sooner. You can be on the winning side of rising home values.
What it costs
to avoid PMI
Assume a different homebuyer
followed “best practices” as recommended by many financial and housing
The buyer chose to avoid PMI.
Instead, he or she opts for a 20% down payment: 15% more than the buyer who
The buyer has some saving to do.
He or she budgets and plans to
accumulate $10,000 per year toward the goal — difficult but doable. In three
and a half years, the buyer raises the full 20% down payment.
But not quite.
He or she is now chasing higher
home prices. In 3.5 years, home prices will have risen nearly 13% —
factoring in compound interest — or around $30,000.
The buyer no longer needs 20% down
based on home prices of three years ago. He or she needs 20% of the
current home price.
That’s an additional $6,000.
The increase pushes out the
buyer’s time frame. He or she must save four years to put 20% down.
During that time, the home buyer forfeits $34,000 in potential home
Add up lost equity and extra down
payment costs, and waiting to buy has cost this buyer $32,000 —
even after considering the PMI expense he or she “avoided.”
There are many good reasons to
delay buying a house, such as saving up closing costs or improving a credit score
to avoid higher interest rates. But skipping PMI
is not one of them.
PMI with direct-to-buyer benefits
PMI benefits the buyer indirectly,
but some mortgage insurance companies now offer buyers direct value, too.
One PMI provider, Radian, layers
its MortgageAssureSM product on top of its standard PMI coverage. This program
offers job loss protection for the buyer.
The insurance covers the
borrower’s payments — up to $1,500 per month for six months — in the case of a
job loss during the first two years of the loan.
The program comes at no additional
cost for home buyers who make a down payment between 3-5% on some loan
This is peace of mind for the
homebuyer and a very good reason to check which PMI providers your lender works
than accepting the PMI rates and providers the lender assigns by default.
Mortgage lenders often work with
three to five PMI providers. Most often, the lender will choose your provider
for you. The choice is often arbitrary or based on who the lender is accustomed
But the borrower can have a say in
the matter. If you know of a PMI provider that offers a certain benefit, don’t
be afraid to ask for it.
The small request could end up
making a big difference later on.
When can I
PMI cancellation should happen automatically when your loan
balance falls to 78% of your home’s original purchase price.
However, you may be able to cancel PMI a little sooner —
when you reach the 80% threshold — by contacting your loan servicer.
Keep in mind that these rules apply only to conventional
loans. Mortgage insurance works differently for subsidized loans such as USDA
and FHA mortgages.
FHA mortgage insurance premium (MIP)
FHA loans, backed by the Federal Housing Administration, require
their own type of mortgage insurance. This is known as mortgage insurance premium,
MIP charges two separate fees: an upfront payment and an
- Upfront mortgage Insurance
Premium (UFMIP) costs 1.75% of the loan amount. It can be paid at closing but
most home buyers roll it into the loan balance
- Annual mortgage insurance premium
(MIP) costs 0.85% of the loan amount per year, split up into 12 installments
and paid monthly with the mortgage payment. This is due the life of the loan
unless you put at least 10% down. In that case, the MIP payments will cancel
after 11 years
Of course, a homeowner could refinance out of an FHA mortgage
to get rid of their MIP payments. If the home’s loan-to-value ratio has fallen
below 80%, refinancing into a conventional loan could help eliminate MIP later
USDA and VA loans
USDA loans also charge both an upfront and ongoing mortgage
insurance fee. However, USDA mortgage insurance rates are slightly lower, with
a 1% upfront fee and 0.35% annual charge.
VA Loans, backed by the federal Department of Veterans
Affairs, do not require ongoing mortgage insurance payments. The VA charges a
funding fee upfront to help insure lenders, but there’s no added monthly charge
for the borrower.
How do I know if PMI is right for me?
Private mortgage insurance isn’t
for everyone, but home buyers should check potential returns before they
automatically refuse it.
Check your home loan options to see what you can afford and how much mortgage insurance would actually cost you.