Mortgage insurance is a policy that protects the lender from losses in the event of borrower default. If a borrower is unable to repay their mortgage, mortgage insurance ensures that the lending company still gets paid. Mortgage insurance is generally required by lenders on loans with low down payments. The upside to mortgage insurance for homebuyers is that it allows for the purchase of a home without a 20 percent down payment.
The cost of mortgage insurance varies according to your down payment amount and credit score. Generally, the lower your credit score and down payment, the higher the cost of the insurance. This coverage is typically paid for monthly alongside your mortgage payments, although lump sum financing and lender paid options are available, depending on the type of insurance you have.
Private Mortgage Insurance (PMI)
This common type of mortgage insurance covers conventional loans and is typically required if the borrower is unable to provide a 20 percent down payment on the home. PMI is usually paid monthly as part of the overall mortgage payment to the lender, and it can be removed after the borrower has paid enough towards the principal amount of the loan to cover the original 20 percent down payment, subject to conditions of the current lender/servicer.
Mortgage Insurance Premiums (MIP)
Federal Housing Administration (FHA) loans carry this government-backed insurance policy. This insurance is paid twofold: first as a larger, one-time Up Front Mortgage Insurance Premium (UFMIP), and then in lower, annual Mortgage Insurance Premiums (MIPs) that are paid in monthly installments.
VA Funding Fee and USDA Guarantee Fee
If you are eligible for and choose a government-insured loan that does not require a down payment, such as a VA (Veterans Affairs) or USDA Rural Housing Loan, you will be required to pay a fee at closing for the funding of your loan. For a VA loan, this is called a Funding Fee. Similar to FHA's Up-Front Mortgage Insurance Premium, this cost is a percentage of your loan amount. The percentage charged will vary depending on if it is your first time using the VA loan benefit and the type of military service you provided. This fee can be financed into the loan amount, and unlike FHA loans, VA loans do not require any subsequent premiums in addition to the funding fee.
USDA loans carry an up-front Guarantee Fee as well as an annual fee that is added to the monthly mortgage payment. The up-front portion of USDA's mortgage insurance can be financed into the loan amount. As of August 2015, USDA's up-front Guarantee Fee is 2 percent of the loan amount for both purchase an refinance transactions, while the annual fee is .50 percent of the remaining principal balance. Please note that these figures change according to USDA guidelines, and in October of 2015 the USDA up-front Guarantee Fee is increasing to 2.75 percent.
While these two insurance policies have the same purpose, there are significant distinctions between them.