What Is Mortgage Insurance and How Does It Work?

Mortgage insurance refers to an insurance policy that protects a mortgage lender from loss if the borrower does not make required payments on time, fails to fulfill other requirements of the mortgage, or dies. Several types of mortgage insurance include private mortgage insurance (PMI) (required for many conventional loans), qualified mortgage insurance premium (MIP) (required for FHA loans), or mortgage title insurance.

Depending on what kind of loan you apply for, the method of paying for mortgage insurance is different:

  • Conventional Loan. Your lender may arrange for a private company to provide mortgage insurance. PMI rates depend on the amount of down payment and your credit score, but if you have good credit, PMI rates are usually cheaper than corresponding FHA rates. Most private mortgage insurance requires monthly payment, with little or no initial payment required at closing. Under certain conditions, you can cancel your PMI.

  • Federal Housing Administration (FHA) Loan. Your mortgage insurance premiums are paid directly to the Federal Housing Administration. All FHA loans require mortgage insurance. FHA rates do not depend on your credit score, but FHA insurance rates may increase in price if your down payment is less than 5%. FHA mortgage insurance includes both an upfront cost, which is paid at closing, and a monthly cost, which is included in your monthly mortgage payment. If you do not have enough money on hand to pay the upfront fee, you can choose to include the fee into your mortgage loan instead of paying it directly. If you choose this option, your loan amount and the total cost of your loan will increase.

  • U.S. Department of Agriculture (USDA) Loan. This kind of loan is similar to, but less expensive than, the Federal Housing Administration loan. You will pay for the insurance on this loan both at closing and as part of your monthly payment.

  • U.S. Department of Veterans Affairs (VA) Loan. The VA guarantee is a substitute for mortgage insurance. VA-backed loans are designed to help service members, veterans, and their families. You do not need to pay a monthly mortgage insurance premium. However, you do need to pay an upfront "funding fee."

Tellus TIP:

No matter what kind of mortgage insurance you purchase, know that this policy is designed mainly to protect the lender rather than the borrower in the event that you default on your payments. If you are not able to pay your loans on time, your credit score may be negatively impacted, and foreclosure may be triggered to take back your home, regardless of whether you have mortgage insurance.