What is mortgage insurance?

Why Does Mortgage Insurance Exist?

Mortgage insurance exists to make homeownership accessible to borrowers who can't make a 20% down payment. Without it, lenders would face too much risk on high-LTV loans and would either refuse to make them or charge significantly higher interest rates.

The insurance protects the lender — not the borrower. If the borrower defaults and the property sells for less than the outstanding balance, the mortgage insurance company covers part of the lender's loss. The borrower still faces foreclosure, credit damage, and potential deficiency liability.

What Are the Three Types of Mortgage Insurance?

• Private Mortgage Insurance (PMI): Required on conventional loans with less than 20% down. Provided by private insurance companies (MGIC, Radian, Essent, Arch, Genworth). Can be borrower-paid monthly, borrower-paid upfront, or lender-paid (built into a higher rate). Key advantage: can be cancelled when equity reaches 20%.
• FHA Mortgage Insurance Premium (MIP): Required on all FHA loans regardless of down payment. Two components: upfront MIP of 1.75% (typically financed into the loan amount) and an annual premium that depends on the loan amount, term and loan-to-value ratio. For loans with less than 10% down, MIP is required for the life of the loan. For loans with 10%+ down, MIP can be removed after 11 years.
• VA Funding Fee: A one-time fee on VA loans that funds the VA loan guaranty program. First-time use with no down payment: 2.15%. Subsequent use with no down payment: 3.3%. Can be financed into the loan. Exemptions include veterans receiving VA compensation for a service-connected disability or eligible for it but receiving retirement or active-duty pay instead, active-duty Purple Heart recipients who provide evidence by closing, and surviving spouses receiving Dependency and Indemnity Compensation (DIC).

PMI vs. FHA MIP: Which Is Better?

The comparison depends on the borrower's credit profile and timeline:

• PMI advantages: Can be cancelled at 20% equity (saving thousands over the life of the loan). Lower cost for borrowers with good credit (720+). Monthly borrower-paid PMI often has little or no upfront payment.
• FHA MIP advantages: Available to borrowers with lower credit scores (580 minimum for 3.5% down). Upfront premium can be financed.
• FHA MIP disadvantage: For most borrowers, MIP lasts the entire loan term. MIP can end when the FHA mortgage is paid in full, including through a sale, payoff or refinance.

For a borrower with a 680+ credit score, conventional with PMI is almost always cheaper long-term because PMI can be cancelled. For borrowers with 580-679 credit scores or high DTI ratios, FHA may be the only available option.

Why Does Mortgage Insurance Matter for Financial Distress?

Mortgage insurance adds a significant cost that doesn't build equity or protect the borrower. For FHA borrowers — who already tend to have lower incomes and higher DTI ratios — the permanent MIP payment compounds affordability stress.