Mortgage insurance is a common requirement for homebuyers who finance more than 80% of their home’s purchase price. While it helps borrowers qualify for a mortgage with a low down payment, it also comes with added costs. Understanding the advantages and disadvantages of mortgage insurance can help homeowners make informed financial decisions.
This guide will explain what mortgage insurance is, its benefits, drawbacks, and whether you can avoid or remove it.
What is Mortgage Insurance?
Mortgage insurance is a policy that protects the lender if the borrower defaults on the loan. It does not protect the homeowner but allows lenders to offer loans with smaller down payments.
There are two main types of mortgage insurance:
- Private Mortgage Insurance (PMI) – Required for conventional loans with a down payment of less than 20%.
- Mortgage Insurance Premium (MIP) – Required for FHA loans, regardless of down payment size.
Other mortgage insurance types include:
- Lender-Paid Mortgage Insurance (LPMI) – The lender pays PMI but charges a higher interest rate.
- VA and USDA Loan Fees – VA loans have a funding fee, and USDA loans have an annual guarantee fee instead of PMI.
Now, let’s explore the pros and cons of mortgage insurance.
Pros of Mortgage Insurance
1. Helps Homebuyers Purchase a Home Sooner
One of the biggest advantages of mortgage insurance is that it allows borrowers to buy a home without waiting to save a 20% down payment.
✅ Instead of waiting years to save, homebuyers can purchase with as little as 3% down (for conventional loans) or 3.5% down (for FHA loans).
✅ This is especially helpful for first-time homebuyers who may not have significant savings.
💡 Example:
- Home price: $300,000
- 20% down payment: $60,000 (may take years to save)
- 5% down payment: $15,000 (more achievable with mortgage insurance)
2. Increases Loan Approval Chances
Lenders are more willing to approve loans with low down payments when mortgage insurance is in place.
✅ This makes homeownership accessible to borrowers with smaller savings.
✅ It also allows borrowers with moderate credit scores to qualify for a loan.
3. Provides More Financial Flexibility
By putting down less than 20%, homebuyers can keep more of their savings for:
✅ Emergency funds
✅ Home repairs and renovations
✅ Investments or retirement savings
💡 Tip: Even if you can afford a 20% down payment, keeping some savings for unexpected expenses is a smart move.
4. PMI Can Be Removed
Unlike other loan fees, PMI is not a permanent cost. Borrowers can remove PMI once they reach 20% home equity.
✅ You can request PMI cancellation when your loan-to-value (LTV) ratio reaches 80%.
✅ Lenders must automatically remove PMI when the LTV reaches 78%.
✅ If home values increase, a new appraisal may help remove PMI sooner.
💡 FHA MIP cannot be removed unless you refinance to a conventional loan.
5. Enables More People to Build Wealth Through Homeownership
Buying a home with mortgage insurance allows borrowers to:
✅ Build home equity instead of renting.
✅ Benefit from home appreciation over time.
✅ Take advantage of tax deductions (in some cases).
💡 Over the long term, homeownership can be a great investment, even with mortgage insurance costs.
Cons of Mortgage Insurance
1. Increases Monthly Mortgage Payments
Mortgage insurance adds an extra cost to the monthly payment, making homeownership more expensive.
❌ PMI typically costs 0.5% to 2% of the loan amount per year.
❌ FHA MIP includes an upfront premium and annual payments.
💡 Example:
- Loan amount: $300,000
- PMI rate: 1% annually
- Extra monthly cost: $250
2. Does Not Benefit the Borrower Directly
Unlike home insurance (which protects the homeowner), mortgage insurance only protects the lender.
❌ If you default, the lender is covered, but you still lose your home.
❌ PMI does not lower your interest rate or improve loan terms.
💡 Mortgage insurance is an added expense with no direct benefits to the borrower.
3. FHA Mortgage Insurance is Harder to Remove
Unlike conventional PMI, FHA Mortgage Insurance Premium (MIP) is permanent unless:
❌ You refinance to a conventional loan.
❌ You pay off the loan entirely.
💡 Tip: If you have an FHA loan, check when refinancing to a conventional loan without PMI makes financial sense.
4. Higher Total Loan Costs Over Time
Since PMI adds to monthly payments, borrowers pay more in total loan costs.
❌ Over a 30-year mortgage, PMI payments can add thousands of dollars to the cost of the loan.
💡 If possible, consider making extra principal payments to remove PMI sooner.
5. Mortgage Insurance Rules Can Change
Government policies on PMI, MIP, and VA/USDA fees can change, affecting costs and cancellation policies.
❌ FHA MIP rules have changed multiple times, sometimes making removal harder.
❌ PMI rates vary based on credit score and lender policies.
💡 Always check the latest mortgage insurance requirements before choosing a loan.
Should You Avoid Mortgage Insurance?
While avoiding PMI can save money, it may delay homeownership. Consider these strategies:
✅ Save for a 20% down payment to avoid PMI.
✅ Use a piggyback loan (80-10-10 loan) to avoid PMI with a second loan for the down payment.
✅ Choose a lender-paid mortgage insurance (LPMI) loan, but be aware of higher interest rates.
✅ Consider VA or USDA loans, which do not require traditional PMI.
💡 If paying PMI allows you to buy a home sooner and start building equity, it may be worth it.
Conclusion: Is Mortgage Insurance Worth It?
Mortgage insurance has both benefits and drawbacks:
✅ Pros: Helps buyers purchase sooner, increases loan approvals, provides financial flexibility, can be removed, and builds home equity.
❌ Cons: Adds costs, benefits the lender only, can be difficult to remove (for FHA loans), and increases total loan expenses.
Final Thoughts:
- If you can afford a 20% down payment, avoiding PMI is ideal.
- If you want to buy a home sooner, PMI can be a temporary but worthwhile expense.
- Look for ways to remove PMI early, such as refinancing or paying down the loan balance faster.
By understanding how mortgage insurance works, homeowners can make smarter financial decisions and minimize costs in the long run. 🚀