Email FacebookTwitterMenu burgerClose thin

What Is Mortgage Insurance and How Does It Work?   


Typically, when you make a down payment that is under 20% of a home purchase, you will have to get mortgage insurance. This lowers the risk for a mortgage lender to give you the money. Here’s a breakdown of what mortgage insurance is and how it works. 

A financial advisor can help you create a financial plan for your home buying needs and goals.

What Is Mortgage Insurance?

Mortgage insurance is a policy that protects lenders from home loan defaults. By mitigating their risk, this insurance offers potential homeowners an opportunity to access mortgage loans that would otherwise be out of reach. 

While mortgage insurance could help facilitate your home purchase, note that this policy doesn’t protect you as the borrower. In the event of a default, the insurance only protects your mortgage lender from loss and will not protect your home if you default on the loan.

One way to avoid mortgage insurance is to make a down payment of at least 20%. However, depending on the loan, you may still need to take out mortgage insurance regardless of how much money you put down. 

Generally, mortgage insurance can be paid as a monthly premium or lump-sum payment. If your mortgage insurance is required because your down payment is under 20%, you may be able to cancel the policy as soon as 20% of your mortgage balance gets paid off.

3 Common Types of Mortgage Insurance

Older couple evaluating their mortgage insurance

Depending on your mortgage insurance, you will get charged monthly, annually, or through a higher interest rate:

Borrower-paid mortgage insurance (BPMI). This is the most common type of mortgage insurance. A monthly premium gets added to your mortgage payment until you have paid off 22% of your original home value. BPMI can usually get canceled once this threshold is met, thereby reducing your monthly mortgage payments.

Lender-paid mortgage insurance (LPMI). This type of mortgage insurance gets paid by the lender. In return for buying a single-premium policy on your behalf, you may get charged a higher interest rate on your mortgage to cover the cost. This will also elevate your monthly payments.

FHA mortgage insurance premium (MIP). When you take out an FHA loan, you will be required to pay this type of mortgage insurance. Payments come in two forms: Upfront premiums that can get financed into your loan or an annual payment that gets added to your mortgage payments. 

How Mortgage Insurance Works With Different Loans

Mortgage insurance operates differently based on your specific loan. Here are three common loan types:

Conventional loans. For these loans, mortgage insurance is typically needed when the down payment is under 20%. The insurance cost can fluctuate based on factors like the borrower’s credit score and loan-to-value ratio.

FHA loans. FHA loans require mortgage insurance, regardless of the size of the down payment. These consist of an upfront premium and an annual premium, both of which can be pricey.

USDA loans. USDA loans require mortgage insurance, but premiums are typically lower than FHAs. Such loans are designed for low and moderate-income borrowers in rural areas. 

VA loans. Unlike other loans, VA loans do not require mortgage insurance. However, borrowers are required to pay a funding fee, which can get financed within the loan amount.

How Much Does Mortgage Insurance Cost?

The cost of mortgage insurance will vary, depending on multiple factors. These include the loan amount, your loan-to-value ratio and credit score. Your mortgage insurance costs can typically range up to 2%. And since this cost is based on a percentage of your mortgage, the more you borrow, the higher it will be.

Bottom Line

A couple calculates the cost of mortgage insurance

Mortgage insurance could help you become a mortgage owner. But this policy is designed to protect only your mortgage lender against a possible default on your payments. Depending on the type of mortgage that you take out, you will have different requirements. So make sure to understand what you’re getting into before you buy.

Tips for Homebuyers

  • A financial advisor can help you reach your home buying goals. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you want to figure out how much home you can buy, SmartAsset’s home affordability calculator can give you an estimate based on your income, savings and monthly debts.

Photo credit: ©, © Creative House, ©