Mortgage Insurance – What It Covers & Why You’ll Need One
Buying a home with a mortgage often comes with a few extra costs, and one of those might be mortgage insurance. If you’re putting down less than 20% on a conventional loan, you’ll likely be required to pay for it. While it adds to your monthly payment, mortgage insurance plays a key role in helping more people become homeowners.
So, what is mortgage insurance, what does mortgage insurance cover, and how does mortgage insurance work? Let’s break it all down.
What Is Mortgage Insurance For?
Mortgage insurance exists to protect mortgage lenders in case a borrower can’t keep up with their payments. It’s not designed to protect the homeowner, it’s there to cover the lender’s losses if a loan goes into default. Because this insurance reduces risk for lenders, it allows them to offer loans to more buyers, even those who can’t afford a large down payment.
This is why conventional loans often require it when the down payment is below 20%. It’s also required on many government-backed loans like FHA loans, although it works a little differently there.
How Does Mortgage Insurance Work?
Mortgage insurance is usually added to your monthly mortgage payment. You won’t pay a separate bill for it, your lender simply includes it in the overall amount you owe each month.
There are three common types of mortgage insurance:
- Borrower-paid mortgage insurance (BPMI): The most common type, BPMI is paid monthly and can eventually be canceled once you reach 20% equity in your home.
- Lender-paid mortgage insurance (LPMI): With LPMI, the lender pays for your mortgage insurance, but you’ll get a higher interest rate instead. You can’t remove it unless you refinance, so it stays with the loan the whole time.
- Mortgage insurance premium (MIP) for FHA loans: FHA loans require both an upfront fee and a yearly insurance premium. Unless you put down at least 10%, you’ll usually pay this for the full length of the loan.
Each option affects your payment structure differently, but the goal is the same: reduce the lender’s risk so they can approve more borrowers.
What Does Mortgage Insurance Cover?
Despite the name, mortgage insurance doesn’t protect your home or belongings. It only covers your lender in case you stop making payments. That means even if you have mortgage insurance, you can still face foreclosure if you fall behind.
It’s easy to confuse mortgage insurance with mortgage protection insurance, which is optional coverage designed to help homeowners cover payments in case of job loss, disability, or death. But the two are entirely different. Mortgage insurance protects the lender. Mortgage protection insurance, if you choose to buy it, protects you and your family.
How Much Does It Cost?
The price of mortgage insurance isn’t the same for everyone. It changes based on things like your loan type, credit score, down payment, and how much you’re borrowing compared to your home’s value.
If you’re paying for PMI yourself, it usually costs between 0.1% and 1% of your loan each year. Let’s say you’re buying a $200,000 home with 5% down; that leaves you with a $190,000 loan. If your PMI rate is 1%, that adds up to about $1,900 a year, or roughly $158 a month on top of your mortgage.
FHA loans use a different system. They charge an upfront fee, usually 1.75% of the loan, and then an annual premium between 0.45% and 1.05%, based on the details of your loan.
Can You Avoid Mortgage Insurance?
It’s possible to avoid mortgage insurance, but it depends on your situation. One common way is to make a 20% down payment on a conventional loan. If you can do that, lenders usually won’t require PMI.
Another option is to apply for a VA loan if you’re a qualified service member or veteran. These loans don’t require a down payment or mortgage insurance.
USDA loans are another path, especially if you’re buying in a rural area. While they don’t have PMI, they do include other built-in fees that work like insurance.
You might also get rid of mortgage insurance later. If your home goes up in value and you’ve built enough equity, usually 20% or more, you could refinance into a loan that doesn’t need it.
From Obstacle to Opportunity
Mortgage insurance often feels like an annoying extra cost, but it’s really a reflection of how much flexibility the housing market has created. Instead of seeing it as a penalty for not putting 20% down, think of it as a stepping stone. It’s a way to secure a home sooner, even if you’re not financially perfect on paper.
