What Is Mortgage Insurance?
If you’re getting an FHA loan, you’ll need to pay this extra cost
Mortgage insurance is a type of insurance policy designed to protect mortgage lenders. If a borrower defaults on their mortgage loan, mortgage insurance steps in and pays off all or a portion of the outstanding balance. On Federal Housing Association (FHA) mortgage loans, this type of insurance, commonly referred to as MIP, is required for all borrowers.
While MIP is similar to its better-known cousin PMI—private mortgage insurance—there are some key differences. Here’s an overview.
What Does Mortgage Insurance Do?
MIP lowers the risk to the mortgage lender by providing a safety net in case the borrower falls behind on their payments. Thanks to this added safety, FHA lenders can service riskier borrowers—those who may have smaller down payments, lower credit scores, more debts, or other blemishes on their financial record.
Similar to PMI, mortgage insurance for FHA loans does not protect the borrower: the insurer’s payment goes to your lender, not you. If you default on your mortgage loan, you could lose your home.
How Much Does MIP Cost?
On FHA loans, mortgage insurance comes with both an up-front cost and an annual premium. The up-front cost is 1.75% of the total loan balance and is typically paid as part of your closing costs. On a $200,000 loan, this would come to $3,500. If you’re unable to pay the up-front fee on the closing day, you can roll the premium into your loan balance and pay it off over time.
Annually, you’ll pay a percentage of your loan amount (the exact number varies depending on your original loan balance, down payment, and loan term). This total is spread out across the year and paid as part of your monthly mortgage payments.
Though you can roll your up-front MIP premium into your loan balance, keep in mind that this 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.
Pros and Cons of MIP
There are advantages and disadvantages that come with MIP. For one, MIP can allow you to get a loan that you might not otherwise have qualified for. It also allows you to buy a home with a smaller down payment (FHA loans often require as little as 3.5%), and it might even help you buy a home sooner (if your savings is what’s holding you back).
On the downside, MIP may be permanent. This means an annual premium and higher monthly payment for the entirety of the loan term. MIP also adds to your up-front costs on the closing day.
Requires a smaller down payment
May make it easier to qualify for a mortgage
May allow you to buy a home sooner
Comes with an up-front costs
Comes with an annual cost
Can be for the length of the loan
If you have a conventional loan, you can cancel your mortgage insurance once you have at least 20% equity in the home. But on FHA loans, MIP is usually there to stay. There are a few exceptions though.
Here are the situations in which you may be able to cancel your MIP.
- 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.
If you don’t fall into one of these two categories, you have another option: you can refinance your FHA loan into a conventional one. To do this without needing PMI (mortgage insurance for conventional loans), you would need to have at least 20% equity in your home before applying.
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. If you’re worried about qualifying, work on increasing your credit score before applying to refinance.
The Bottom Line
Mortgage insurance has its pros and cons. On the upside, it can help you qualify for a mortgage loan you might not otherwise have qualified for. Unfortunately, it also increases your costs both up-front and over the life of your loan.
If you’re considering a mortgage loan that requires MIP, 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 at your disposal. Take time to shop around, compare quotes and terms, and be extra sure you’re getting the best deal.
Consumer Financial Protection Bureau. "Mortgage Insurance." Accessed October 15, 2019.
Consumer Financial Protection Bureau. "What is Mortgage Insurance and How Does it Work?" Accessed October 15, 2019.
U.S. Department of Housing and Urban Development. "Mortgage Insurance Premiums." Accessed October 15, 2019.
Department of Housing and Urban Development: Let FHA Loans Help You
Consumer Financial Protection Bureau: When can I remove private mortgage insurance (PMI) from my loan?
U.S. Department of Housing and Urban Development. "Discontinuing Monthly Mortgage Insurance Premiums." Accessed October 15, 2019.
Consumer Financial Protection Bureau: What is Private Mortgage Insurance?