What Is Mortgage Insurance?
Definitions and Examples of Mortgage Insurance
A mortgage insurance policy (MIP) protects mortgage lenders by paying off all or a portion of the outstanding balance if a borrower defaults on their mortgage loan. MIP is similar to its better-known cousin private mortgage insurance (PMI), but there are some key differences.
MIP is required for all borrowers on Federal Housing Association (FHA) mortgage loans. PMI is payable on conventional loans.
What Is Mortgage Insurance?
Mortgage insurance ensures that your mortgage will be paid. It guarantees that the balance will be paid off even if you stop making payments. Similar to PMI, mortgage insurance for FHA loans does not protect the borrower. The insurer’s payment goes to your lender if the policy pays out, not to you. You can still lose your home to foreclosure if you default on your mortgage loan even if the policy has paid it off.
- Acronym: MIP
How Mortgage Insurance Works
MIP lowers a mortgage lender's risk by providing a safety net in case the borrower falls behind on payments. FHA lenders can service riskier borrowers thanks to this added safety—those who might have smaller down payments, lower credit scores, more debts, or other blemishes on their financial records.
Pros and Cons of Mortgage Insurance
On the upside, paying mortgage insurance can help you qualify for a loan that you might not otherwise have been approved for. Unfortunately, it also increases your costs, both upfront and over the life of the loan.
Make sure you understand the full scope of your short- and long-term costs, as well as what other mortgage loan options you might have. Take time to shop around, compare quotes and terms, and be sure you’re getting the best possible deal if you’re considering a mortgage loan that requires MIP.
MIP also allows you to buy a home with a smaller down payment. FHA loans often require as little as 3.5% down. This might help you buy a home sooner if your lack of substantial savings is what’s been holding you back.
On the downside, MIP might be permanent. You'll pay an annual premium and a higher monthly payment for the entire life of the loan term. MIP also adds to your upfront costs on closing day.
Requires a smaller down payment
Can make it easier to qualify for a mortgage
Can allow you to buy a home sooner
Comes with an upfront cost
Comes with an annual cost
Can be for the length of the loan
Do I Need to Pay for Mortgage Insurance?
The upfront cost for mortgage insurance is 1.75% of the total loan balance, and it's typically paid as part of your closing costs. This would work out to $3,500 on a $200,000 loan. You can sometimes roll the premium into your loan balance and pay it off over time if you’re unable to pay the upfront fee on closing day, but you'll have to pay it eventually.
You’ll then pay a percentage of your loan amount annually. The exact number will vary depending on your original loan balance, your down payment, and the loan term. This total is spread out across the year and paid as part of your monthly mortgage payments.
Keep in mind that rolling your upfront MIP premium into your loan balance will increase your overall costs to borrow. Not only will your balance be higher, but you’ll also pay more in interest over the long run.
Can I Remove MIP?
You can cancel your mortgage insurance on a conventional loan when you have at least 20% equity in the home, but MIP on FHA loans is usually there to stay. There are a few exceptions, however. You might be able to cancel your MIP if:
- You made a 10% down payment on closing day and you’ve been in the home for at least 11 years.
- Your mortgage loan was originated between January 1, 2001, and June 3, 2013, and you have at least 22% equity in the home.
You might have one more option if you don't fall into one of these two categories. You can refinance your FHA loan into a conventional mortgage. You would need to have at least 20% equity in your home before applying to achieve this without needing PMI (mortgage insurance for a conventional loan).
Conventional mortgage loans usually have stricter requirements than FHA loans, and you’ll likely need a higher credit score and lower debt-to-income ratio in order to qualify. Work on increasing your credit score before applying to refinance if you're concerned about qualifying.
- Mortgage protection insurance (MIP) is required on all FHA loans.
- MIP is similar to private mortgage insurance (PMI) required on some conventional loans.
- MIP protects the lender. It will pay the remaining mortgage balance to the lender if the borrower should default and stop making mortgage payments, but this doesn't avoid foreclosure.
- The MIP requirement will increase your closing costs, as well as your monthly mortgage payments.