- Borrowers pay mortgage insurance, which protects lenders from defaults.
- Conventional mortgage lenders must eliminate insurance when the borrower has 22% equity in the home.
- Homeowners can implement strategies to get out from under this expense even sooner.
If you buy a home with a mortgage and make less than a 20% down payment, you’ll probably face the added cost of mortgage insurance. Depending on the amount you borrow and your credit score, it can have a big impact on your monthly payment.
This added cost protects the lender, not you. The amount of time you’ll have to pay for mortgage insurance will vary based on the type of loan and the down payment amount. In any case, there are steps you can take to get rid of mortgage insurance sooner rather than later.
What is mortgage insurance?
Mortgage insurance comes into play when homebuyers buy down less than 20% on a home purchase. Although lenders are willing to finance the loan with a smaller down payment, they view a low down payment as a risk. And with that risk comes mortgage insurance, paid by the borrower.
Mortgage insurance protects the lender in case you stop making your mortgage payments. That’s in contrast to homeowners insurance, which is also required when you have a mortgage and protects you and your home against covered losses. For example, homeowners insurance might pay out a claim to help you repair your roof after a storm.
When financing a home, you’ll almost certainly be required to pay for mortgage insurance — or face a higher interest rate — if you make less than a 20% down payment.
Mortgage insurance for conventional loans
If using a conventional mortgage for your home purchase, most lenders will require you to pay private mortgage insurance (PMI) if you put less than 20%. In some cases, they might choose to waive the requirement in exchange for a higher interest rate. However, in such scenarios your overall cost of borrowing can often end up being higher than it would be with PMI.
There are two types of PMI.
The most common is borrower-paid. When you close on the loan, the lender will let you know the monthly cost. Typically, you can roll this expense into your regular mortgage payment. But you might have the option to pay for it separately each month. With borrower-paid PMI, the lender is required to cancel the payments when you build 22% equity in your home or reach the midpoint of your loan’s amortization schedule.
The second type of PMI is lender-paid. The lender covers the cost of the insurance, but charges you a higher interest rate to offset the expense. Unlike borrower-paid PMI, which can be cancelled, the higher interest rate associated with lender-paid mortgage insurance sticks with you for the entire loan term.
Mortgage insurance for FHA loans
An FHA loan is a government-backed mortgage option guaranteed by the Federal Housing Administration. The insurance you pay on these loans is referred to as a mortgage insurance premium (MIP).
As an FHA borrower, you’ll pay 1.75% of your loan’s total at closing. After that, you’ll pay an annual premium ranging from 0.45% to 1.05%, in most cases for the life of your mortgage.
How much does mortgage insurance cost?
Mortgage insurance costs can add up quickly.
According to data from the Urban Institute, PMI can range from 0.58% to 1.86% of your loan amount. Although the exact monthly cost will vary, Freddie Mac estimates you’ll pay between $30 to $70 per month in PMI for every $100,000 borrowed. That’s amounts to $360 to $840 annually for a $100,000 loan.
5 ways to get rid of mortgage insurance faster
Luckily, it’s possible to wipe out mortgage expense sooner rather than later. Here are some strategies to kick this expense to the curb.
1. Ask your lender to cancel it
Conventional mortgage lenders have the power to require mortgage insurance payments. But they also have the ability to strip away this costly payment. Sometimes, it’s as simple as giving your lender a call.
“The first step is to contact your lender and ask if you can cancel your mortgage insurance,” says Michael Ryan, a financial coach at Michael Ryan Money.
A good time to call is when you build 20% equity in your home. However, lenders don’t have to honor your request at the 20% mark. If they deny your request, cancellation is still on the horizon since they are legally required to eliminate mortgage insurance when you’ve built 22% equity in your home.
Refinancing your mortgage can give you an expedited way out of this costly payment. But you’ll need to have at least 20% equity in your home and choose a refinance option that doesn’t involve taking cash out. This option can help you get rid of the mortgage insurance on either a conventional or FHA loan.
“Remember that you don’t have to refinance with your current lender,” says Paul Sundin, a certified public accountant and CEO of Emparion, a provider of strategic retirement services. “You can work with other lenders. Once you apply for refinancing, wait until the appraisal and underwriting processes are completed.”
3. Reappraise your home
If your home has gone up in value, that can help you hit the 20% equity mark.
“Track the market value of your home by registering with platforms like Zillow or Redfin,” recommends Andrew Latham, a CFP® professional and content director at SuperMoney.
“Once your loan-to-value ratio gets to 80%, contact your lender and ask about their private mortgage insurance (PMI) protocol,” Latham says. In some cases, the lender may send out a professional appraiser to consider the value of your property.
Before the appraiser shows up, “go through the property with a critical eye and make sure everything is working correctly,” Latham advises. If anything could detract from the value of your home in a big way, make any fixes you can before the new appraisal, he says.
4. Consider home improvements
Many factors contribute to the market value of your home. Of course, the general market trends are beyond your control. But targeted home improvements can also increase your home’s value.
Latham advises focusing on improvements that provide the best return on investment, such as renovating bathrooms and kitchens. He notes that most lenders will require a list of improvements. So, keep detailed documentation along the way. If the projects increase your home equity ownership to at least 20%, reach out to the lender about canceling PMI.
You can also expedite the cancellation of your PMI by making extra payments that bump you up to 20% equity ahead of schedule. If you have room in your budget, putting more money towards your mortgage’s loan balance can get you to the finish line faster.
If you don’t have room in your monthly budget, then consider putting extras that come your way towards the loan balance.
“If you receive bonuses at work, set them aside as additional mortgage principal payments,” suggests Ryan McCarty, a CFP® professional and owner of McCarty Money Matters. Another potential payment strategy he suggests is that “if you pay off another debt, use those dollars to add to your mortgage payment until the PMI is removed.”
The bottom line
“Mortgage insurance is a blood sucker,” says McCarty. Although the availability of private mortgage insurance means you can get into your home without saving up a 20% down payment, the extra expense is a drain on your budget.
As a borrower, there are ways to eliminate your mortgage insurance costs early. If a strategy works for your situation, move forward confidently to put more wiggle room in your budget.