Probably the most mysterious part of the mortgage process is mortgage insurance. It will affect most mortgage borrowers, and especially first-time homebuyers so it’s worth knowing something about. You don’t need to be an expert, but it will help to have an idea how to estimate mortgage insurance premiums, since they will be a part of your monthly housing payment.
What is Mortgage Insurance?
Any time a mortgage lender makes a loan in which you have less than 20% equity in the property, you’ll be made to pay mortgage insurance. This is because loans in which the owner of the property has less than 20% equity are considered higher risk loans, with a higher likelihood of default.
In order to make such loans, the mortgage lender will get the mortgage insurance company to provide an amount of mortgage insurance that effectively lowers the mortgage loan to something below 80% of the property value. Mortgage insurance may lower the effective loan balance from say 95%, down 68% of the property’s value.
If you have less than 20% equity in the house that you are either buying or refinancing, you will be required to take mortgage insurance as part of the mortgage. You’ll have to pay monthly premiums for the coverage, and it will be included in your monthly mortgage payment.
What Mortgage Insurance Isn’t
Mortgage insurance is sometimes confused with mortgage life insurance which is actually a completely different form of insurance. Both pay the lender, but one pays in the event of default, while the other pays as a result of death.
Mortgage insurance actually insures the lender for a certain percentage of the mortgage. In the event that you default on your mortgage, the mortgage insurance company will pay a claim to the lender. The fact that the mortgage insurance company has made this payment does not relieve your burden, as the borrower, to make good on the full amount of the loan. It only reduces the mortgage lender’s risk in the event of your default.
Mortgage life insurance is coverage that you purchase that will pay off your mortgage in the event of your death. The proceeds are paid directly to the mortgage lender when you die, relieving your dependents of the need to pay the loan.
Factors that Affect Mortgage Insurance Premiums
When it comes to mortgage insurance premiums, there is no one-size-fits-all. Rates are based on factors that include some or all of the following:
- Loan-to-value ratio, or LTV
- Credit scores
- Type of loan
- Insurance coverage percentage required by the lender or loan program
- Loan term
- Loan amount
- Type or use of property
- Refinance and cash out refinance
- Type of premium plan
Like most types of insurance coverage, mortgage insurance is determined by a matrix of factors reflecting the considerations above. It’s a complicated calculation for a person not familiar with the process, but there are some rules of thumb to apply to typical borrowers.
How Much Does Mortgage Insurance Cost?
There are several mortgage insurance companies, including MGIC, RMIC and PMI. Despite the number of providers, premium rates are fairly standard across the industry.
Rates will vary based on all of the factors above so it’s impossible to generalize exactly what your premium might be. But you can use the following as a rule of thumb based on several common loan characteristics, including a 30 year fixed rate loan not exceeding $417,000 on an owner occupied single family home, where the borrower has credit scores between 680 and 719.
Based on those characteristics and the loan-to-value ratios below, the typical annual premiums will look like this:
80.01% to 85.0% – .43%
85.01% to 90.0% – .62%
90.01% to 95.0% – .94%
95.01% to 97.0% – 1.10%
You can calculate your monthly mortgage insurance by multiplying one of the factors above by your loan amount and dividing it by 12 months. For example, let’s say you’re taking a $200,000 mortgage that is 95% of the value of the home you are buying or refinancing. Your premium rate factor will be .94%, or $1,880 ($200,000 X .94%) per year. By dividing that number by 12 months, your monthly premium will be $156.67.
The good news is that as the balance of your loan declines, so will the monthly mortgage insurance premium. When your loan falls to 78% of the original property value, the insurance can be terminated.
Depending upon your loan terms and credit profile, the actual premium will be different. But the rates above will give you a basic estimate to work with until more complete numbers can be determined.
If you’d like to get more specific numbers you can check out the MGIC Rate Card.
FHA Mortgage Insurance Premiums
Loans backed by the Federal Housing Administration (FHA) calculate mortgage insurance differently. The typical FHA 30 year loan has an upfront mortgage insurance premium of 1.25% of the mortgage amount, and that premium can be added to the mortgage amount and paid off over the life of the loan. On a loan of $200,000 this would result in an upfront mortgage insurance premium of $2,500.
In addition, FHA also adds a monthly mortgage insurance premium based on an annual rate of .55% of the mortgage amount. On a loan amount of $200,000, that would be $1,100 each year, or $91.67 per month. But this amount will decline gradually since it is based on the remaining mortgage balance, which is itself being paid down a little each month.
Do you currently have mortgage insurance on your mortgage? Have any questions about mortgage insurance premiums? Leave a comment!
{ 9 comments… read them below or add one }
This article is very helpful and provides a clear explanation of this somewhat mysterious fee.
However, I would recommend that if you don’t have at least a 20% downpayment, you shouldn’t be buying in the first place. Why on earth would you let the bank take another $156 per month from you (as in the example above), on top of the loan payment?
Walk, no, run, to your nearest Dave Ramsey Financial Peace University class offered in a location nearest you.
Stop the madness!
I agree Michael! 20% down is a must… wish I knew that years ago!
I guess it all depends on where you’re living and the cost of the house you’re purchasing. While I’m stuck paying PMI, it’s no where near as bad as the example given.
I do, unfortunately. My wife and I were pretty young when we got married and we didn’t have the full 20% to put down. We’re now stuck with PMI until we either hit the date the 20% was originally to be reached or we pay off the house (which will come before the date of the original 20%).
It’s frustrating to know that the mortgage lender won’t work with us. If refinancing wasn’t so expensive, I’d consider doing that to get out from under the PMI.
Good post! Luckily, we do not have mortgage insurance b/c we paid 20% down – this is our second home purchase. The first home (no longer own) was a VA loan and it is important to note that VA loans do not require mortgage insurance. That is one of the beneifts of being active or retired military. I wrote a post about insurance on my blog too.
I believe the FHA upfront mortgage insurance premium is actually 1.75% and the monthly FHA mortgage insurance premium is 1.25% (if you put down just the 3.5% downpayment) – which would make monthly PMI on a $200,000 loan $208.33. AND … I also read that as of this month (January 2013) the monthly rate may be raised to 2.05% which would be a monthly PMI payment of $341.67.
Most dramatically, the PMI on FHA loans will last for the entire 30 years!
Can you cancel your FHA mortgage insurance after you have paid on your loan for 17 years? My lender saids that we can’t cancel. Is this true?
Thanks,
Teresa
Teresa, from my understanding, it’s only removed after the original date you were scheduled to hit 20% or after your house has increased in value to the point your equity is 20% above.
I was told something similar to you as I’ve paid below 20% and cannot remove the PMI insurance. Such a scam…
Thanks for the clear explanation and useful rule of thumb calculations. This will be very helpful in explaining PMI to my first-time home buying clients!
Your site is great, keep up the good work! God Bless.