How is Mortgage Insurance Calculated

Buying a home is a major financial decision that requires a significant amount of planning and preparation. As part of the home buying process, you may need to obtain a mortgage to finance the purchase of your home. When obtaining a mortgage, you may also be required to pay for mortgage insurance. In this article, we will explain how mortgage insurance is calculated, what factors may impact the cost of mortgage insurance, and frequently asked questions about mortgage insurance.

What is Mortgage Insurance?

Mortgage insurance is a type of insurance policy that protects the lender in the event that you default on your mortgage payments. If you have a conventional loan and you put down less than 20% of the home’s purchase price, you are required to purchase private mortgage insurance (PMI). If you have an FHA loan, you are required to pay for mortgage insurance premiums (MIP).

The cost of mortgage insurance is typically added to your monthly mortgage payment, making your overall mortgage payments higher. As a result, it is important to understand how mortgage insurance is calculated and what factors may impact its cost.

How is Mortgage Insurance Calculated?

Mortgage insurance premiums are calculated differently depending on the type of loan you have.

PMI Calculation

If you have a conventional loan and are required to purchase PMI, the cost of the insurance is based on the loan-to-value (LTV) ratio of your mortgage. The LTV ratio is the amount of your loan compared to the value of your home. The higher the LTV ratio, the greater the risk to the lender. As a result, the cost of PMI will be higher for loans with higher LTV ratios.

The amount of PMI you pay is typically between 0.3% and 1.5% of the original loan amount per year. For example, if you have a $200,000 loan and your PMI rate is 1%, you would pay $2,000 per year, or $166.67 per month, for PMI.

PMI Example

Loan Amount
LTV Ratio
PMI Rate
Annual PMI Cost
Monthly PMI Cost
$200,000
95%
1%
$2,000
$166.67
$400,000
85%
0.5%
$2,000
$83.33

MIP Calculation

If you have an FHA loan, you are required to pay for mortgage insurance premiums (MIP). The amount of MIP you pay is based on the loan amount, loan term, and LTV ratio. The MIP rate varies depending on these factors.

The MIP rate for most FHA loans is 0.85% of the loan amount per year, divided by 12 months. For example, if you have a $200,000 loan and your MIP rate is 0.85%, you would pay $142.50 per month for MIP.

MIP Example

Loan Amount
Loan Term
LTV Ratio
MIP Rate
Annual MIP Cost
Monthly MIP Cost
$200,000
30 years
96.5%
0.85%
$1,447.50
$120.63
$400,000
15 years
90%
0.45%
$1,800
$150

Factors that Impact Mortgage Insurance Cost

The cost of mortgage insurance may vary based on a number of factors, including:

  • Loan amount
  • Loan term
  • LTV ratio
  • Credit score
  • Type of loan

For example, if you have a lower credit score, you may be required to pay a higher rate for mortgage insurance. Similarly, if you have a higher LTV ratio, you may be required to pay a higher rate for PMI.

Frequently Asked Questions About Mortgage Insurance

What is the purpose of mortgage insurance?

The purpose of mortgage insurance is to protect the lender in the event that you default on your mortgage payments.

How long do I need to pay for mortgage insurance?

The length of time you need to pay for mortgage insurance varies depending on the type of loan you have. If you have a conventional loan with PMI, you typically need to pay for mortgage insurance until your LTV ratio reaches 80%. If you have an FHA loan with MIP, you need to pay for mortgage insurance for the life of the loan, unless you refinance.

Can I cancel my mortgage insurance?

If you have a conventional loan with PMI, you can request to cancel your mortgage insurance once your LTV ratio reaches 80%. If you have an FHA loan with MIP, you can request to have your mortgage insurance removed once your LTV ratio reaches 78%.

How can I reduce the cost of mortgage insurance?

The best way to reduce the cost of mortgage insurance is to make a larger down payment on your home. If you put down 20% or more, you may not be required to pay for mortgage insurance at all. Additionally, you can improve your credit score, which may help reduce the cost of mortgage insurance.

Is mortgage insurance tax deductible?

If you have a mortgage insurance premium that is included in your monthly mortgage payment, you may be able to deduct this amount on your federal tax return. However, there are income limitations and other rules that apply, so it is important to consult with a tax professional to determine if you are eligible to claim this deduction.

Can I shop around for mortgage insurance?

Yes, you can shop around for mortgage insurance just like you can shop around for a mortgage. You may be able to find a better rate by comparing quotes from different insurance providers.

Conclusion

Mortgage insurance is an important aspect of the home buying process that can impact the cost of your monthly mortgage payment. Understanding how mortgage insurance is calculated and what factors may impact its cost can help you make informed decisions about your home purchase. If you have any questions about mortgage insurance, be sure to consult with your lender or a qualified professional.