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What is mortgage insurance, and how does it work?

Updated 8 min read

Mortgage insurance is very different from the typical types of insurance we buy to protect ourselves from financial loss. Usually, we pay an insurance company a monthly premium to help cover our home, car, or even our health from an unexpected setback, such as flood damage, an accident, or major illness.

But mortgage insurance doesn't protect a home buyer — it protects the lender from a financial loss if you don't repay your mortgage loan. However, you still benefit in a way. Here's how mortgage insurance works.

Read more: First-time home buyer in 2024 — What you need to know

Mortgage insurance was developed to encourage mortgage lenders to expand their loan offerings to home buyers with limited savings. By charging a fee to borrowers, lenders have a financial cushion to help defray losses from the small percentage of loans that default and go into foreclosure. That allows loan programs with lower down payments and easier credit eligibility.

So, while borrowers pay the insurance premium that benefits lenders, adding to the cost of a mortgage, it allows more people to qualify for homeownership.

If you can make at least a 20% down payment and qualify for a conventional mortgage, you will not be required to purchase mortgage insurance. But other situations will require mortgage insurance of one sort or another.

Mortgage insurance can be labeled differently, depending on the type of mortgage you are applying for.

When a borrower makes a down payment of less than 20% on a conventional loan, they must purchase what is called private mortgage insurance (PMI). It is usually due monthly and built into the regular loan payment, but can also be an up-front payment made when closing on a house.

All FHA loans charge mortgage insurance premiums (MIP). It is an upfront fee paid at closing or carried into the total loan amount, as well as a premium that is added to the monthly mortgage payment.

Learn more: What is an FHA loan, and how do you qualify?

Loans guaranteed by the Department of Veterans Affairs don't charge mortgage insurance per se — but there's a catch. VA loans have an initial "VA funding fee." So, while it is not called mortgage insurance, it serves the same purpose.

Read more: How VA loans work

Mortgages insured by the Department of Agriculture, called USDA loans, have insurance premiums paid at closing or rolled into the loan balance and are also due monthly. USDA mortgage insurance is usually referred to as a "guarantee fee."

Learn more: How to get a USDA loan

Mortgage protection insurance is a life insurance policy that pays your mortgage after you die. Your mortgage lender is listed as the beneficiary of the policy instead of your family members, then your lender uses the payout for your mortgage.

Mortgage protection insurance (also called mortgage protection life insurance) can be useful to people who can’t qualify for or afford traditional life insurance due to illness or a high-risk job. However, your family members may be left without a safety net under this kind of policy.

Mortgage title insurance protects homebuyers and lenders from any financial losses if there’s an issue with the title, such as if the seller didn’t have a legal claim to the house or they had outstanding liens. Mortgage title insurance remains in place the entire time you own the property.

Read more: How much money do I need to buy a house?

As we've seen, what mortgage insurance is called varies among the different types of mortgage loans. Mortgage insurance costs differ as well.

Conventional loans: PMI costs are based on your loan amount, down payment, and credit score. It can be an up-front fee, an ongoing monthly charge, or both. According to Freddie Mac, monthly PMI costs are roughly $30 to $70 for every $100,000 you borrow.

FHA loans: The up-front MIP will cost 1.75% of the loan amount. For example, on a $200,000 loan, it would total $3,500 to be paid at closing or added to the loan amount. Ongoing annual premiums range from 0.15% to 0.75% of the remaining financed mortgage balance, divided by 12 and added to the monthly payment.

VA loans: VA loan funding fees are based on the type and amount of the loan and the down payment and range from 1.25% to 2.15% for first-time loans. The VA funding fee is waived for borrowers with service-connected disabilities or in some other instances. Your exemption status should be reflected in your VA Certificate of Eligibility (COE).

USDA loans: The guarantee fee on USDA loans is an upfront 1% and an ongoing annual fee of 0.35% of your loan balance.

Mortgage protection insurance: Mortgage protection insurance prices are calculated based on your age, the amount of coverage you want, the purchase price of the home, and the term of coverage, usually expressed in years. Depending on those factors, the monthly cost can be up to $100.

Mortgage title insurance: Unlike other types of mortgage insurance that are paid monthly, mortgage title insurance is paid in a lump sum along with your other closing costs. The cost varies by state and typically ranges from 0.5% to 1% of the home’s purchase price.

Your up-front VA funding fee rate depends on two factors: your down payment amount and whether this is your first VA loan. You'll pay 1.25% with a down payment of 10% or more and 1.50% with a down payment of 5% to 10%, regardless of whether this is a first or subsequent VA loan. The only difference is if you make a down payment of less than 5% — then your rate will be 2.15% for the first loan but 3.30% for a subsequent loan.

Your FHA annual premium depends on a variety of factors, including your loan term length, your loan-to-value (LTV) ratio, and whether you take out a conforming or jumbo loan.

The IRS allowed mortgage insurance to be deducted on itemized tax returns through Dec. 31, 2021. That deduction has expired and is no longer available.

Conventional loans: Generally, PMI can be canceled once a homeowner has 20% equity in the home. This can be achieved with mortgage payments reducing the principal loan balance or combined with the increase of a home's current market value, though you'll probably have to pay for an appraisal. Cancellation is also possible by refinancing your mortgage with 20% equity.

A lender may also automatically cancel PMI once the equity in your home reaches 22%, but it's worth contacting your lender or loan servicer to confirm that.

PMI can also be canceled once you are halfway through your loan term, for example, having paid 15 years on a 30-year loan.

FHA loans: With a down payment of 10% or more, FHA mortgage insurance will be removed after 11 years. Loans with a down payment of less than 10% pay MIP for the life of the loan.

VA loans: VA loan funding fees financed as a part of the loan last the loan's lifetime. However, there are no ongoing charges if you pay the funding fee at closing.

USDA loans: The ongoing annual mortgage insurance premium lasts for the life of the loan.

Mortgage protection insurance: Like most life insurance policies, mortgage protection insurance can be canceled anytime. You simply need to notify your insurer via phone or mail that you need to cancel your policy and stop making monthly payments.

Mortgage title insurance: Since you are required to pay for mortgage title insurance in a lump sum upfront, it is uncommon to cancel your title insurance after purchasing it.

Mortgage insurance protects your mortgage lender from losses should you default on your mortgage. It's different from homeowners insurance, which protects you if anything goes wrong with your house, such as a hurricane or robbery.

It depends on what type of loan you have. With a conventional mortgage, you can cancel private mortgage insurance (PMI) as early as when you reach 20% equity in the home. You'll pay FHA mortgage insurance for the life of the loan unless you made a 10% down payment — then it will be removed after 11 years. USDA mortgage insurance lasts for the entire mortgage term. The VA funding fee can be a one-time fee at closing, or you may choose to roll it into your mortgage and pay it off over your term.

It can be expensive to get mortgage insurance, but it depends on your perspective. For example, you might pay $150 monthly for private mortgage insurance. If that's a stretch on your monthly budget, it might be expensive enough for you to consider whether you can afford a house right now.

Mortgage insurance protects the mortgage lender financially should you default on your monthly payments. Homeowners insurance protects the homeowner financially if something happens to the home or your possessions. For example, homeowners insurance would be in charge of reimbursing you for any items stolen if someone broke into your house.

Yes, you can request for your lender to cancel private mortgage insurance (PMI) on your conventional loan once your loan-to-value ratio (LTV) reaches 80%. This rule does not apply to other types of mortgages, though, such as FHA or USDA loans.

To avoid paying for mortgage insurance on a conventional loan, make a 20% down payment. Other types of home loans require mortgage insurance, though. You might hear a different term used for mortgage insurance, though, including "funding fee" for VA loans and "guarantee fee" for USDA loans.