A First-Time Buyer’s Guide to Mortgage Insurance (FHA and PMI)

Mortgage insurance is super confusing, especially for first-time home buyers. But don’t worry. Our experts will break it down for you!

In a hurry? Here are the five most important takeaways:

1. Mortgage insurance is often required with down payments below 20%.
2. It allows you to buy a home sooner, by reducing the down payment.
3. Mortgage insurance protects the lender, but the borrower pays for it.
4. Both FHA and conventional loans can require mortgage insurance.
5. It’s added to the monthly payments, on top of principal and interest.

What Is Mortgage Insurance, Exactly?

Most first-time home buyers in the United States end up paying mortgage insurance, as a result of making a relatively low down payment. But what is it, exactly?

Definition: Mortgage insurance is a type of insurance policy that protects the lender in case the borrower defaults on their monthly payments. It protects the lender, not the homeowner. 

Most first-time buyers use a loan to cover most of the purchase price. This means the lender invests even more money than the buyer. So they want to make sure they’re covered, in case the borrower can’t make their payments.

Mortgage insurance protects the lender in case you default on your loan. If that happens, the insurance company will step in to reimburse the lender for some of their losses.

(But you can benefit from it, as well. More to follow on that.)

Why Do Some Home Buyers Have to Pay It?

Mortgage insurance is usually required in situations where a borrower makes a relatively low down payment. Lenders view borrowers with lower down payments as riskier, because they have less equity in the property.

By requiring mortgage insurance on such loans, lenders can mitigate some of this risk that’s involved.

Here are the typical requirements for different types of loans:

• FHA loans: mortgage insurance is required for all home buyers
• Conventional: it’s required with a loan-to-value ratio above 80%
• VA loans: mortgage insurance is not required, a major benefit

Government vs. Private Mortgage Insurance Costs

There are two main types of mortgage insurance for first-time buyers. They relate to the two most popular types of home loans: FHA and conventional.

The cost can vary based on the type of mortgage insurance, the loan amount, the size of the down payment, and other factors. So let’s tackle them one at a time…

---

Part 1: FHA Mortgage Insurance

FHA mortgage insurance is provided by the Federal Housing Administration and is required for all FHA purchase loans. FHA loans are a kind of government-backed mortgage, where the government provides insurance protection to lenders.

Many first-time home buyers use the FHA program when buying a house. That’s because it allows for a down payment as low as 3.5%. Low down payment programs attract first-time buyers, who don’t have profits from a previous sale to finance their next purchase.

FHA loans require an upfront mortgage insurance premium that equals 1.75% of the loan amount. There’s also an annual premium that comes to 0.55% for most borrowers. Both premiums can be rolled into the loan.

Here’s what the monthly cost for FHA mortgage insurance might look like for different loan amounts, using the 0.55% annual premium mentioned above.

Loan Amount	Monthly MIP Cost
$200,000	$91.67
$300,000	$137.50
$400,000	$183.33
$500,000	$229.17
$600,000	$275.00
$700,000	$320.83

Most first-time home buyers who use an FHA loan have to pay mortgage insurance for as long as they keep the loan, meaning it cannot be cancelled. But for borrowers who make a down payment of at least 10%, FHA mortgage insurance usually expires after 11 years.

---

Part 2: Private Mortgage Insurance (PMI)

PMI applies to conventional loans, which are not backed by the government. It’s called “private” mortgage insurance because it’s provided by insurance companies in the private sector, as opposed to coming from the government.

With a conventional loan, PMI is typically required for home buyers who make a down payment less than 20%, resulting in a loan-to-value (LTV) ratio above 80%. First-time buyers who put down 20% or more on a conventional loan can avoid private mortgage insurance altogether.

On average, the cost of PMI ranges from 0.58% to 1.86% of the loan amount, per year. Dividing that by 12, here’s what the monthly cost would be for different loan amounts.

Loan Amount	Monthly PMI Range
$200,000	$96 – $310
$300,000	$145 – $465
$400,000	$193 – $620
$500,000	$241 – $775
$600,000	$290 – $930
$700,000	$338 – $1,085
$800,000	$386 – $1,240

Unlike FHA mortgage insurance, which is required for all borrowers, PMI can be avoided if a first-time home buyer makes a down payment of 20% or more.

PMI can also be cancelled later on. When a homeowner consistently makes monthly payments and reaches an equity level of 80%, they have the option to request PMI cancellation from their lender or loan servicer.

Additionally, loan servicers are obligated to automatically terminate PMI when the borrower’s loan balance drops to 78% of the property value.

---

How It Benefits First-Time Home Buyers

First-time home buyers are often perplexed when they discover they have to pay for a special type of insurance that benefits the mortgage lender.

What’s often overlooked is that mortgage insurance can benefit the home buyer, as well. In short, it allows you to buy your first home sooner, by significantly reducing the amount of money you have to save for a down payment.

Without mortgage insurance, many buyers would be unable to afford a home because they wouldn’t have the required 20% down payment. For a typical first-time buyer, saving up for a 20% down payment could take years.

Private mortgage insurance can also increase your housing options. By reducing the amount of money you need for the down payment, PMI allows you to purchase a more expensive home that would otherwise be out of reach.

Bottom line: Mortgage insurance allows borrowers to secure a loan with a down payment as low as 3% to 5%. This makes homeownership more accessible to a much larger group of first-time home buyers, particularly those with limited funds in the bank.

Avoiding PMI With a “Piggyback” Loan Strategy

You just learned that private mortgage insurance (PMI) is usually required for conventional home loans with a loan-to-value ratio greater than 80%. This means you’ll probably have to pay for PMI if you take out a single mortgage loan that accounts for more than 80% of the home’s value.

But what if you took out two loans?

Even with a down payment below 20%, first-time home buyers could avoid PMI by using what’s known as a “piggyback” mortgage strategy.

This involves taking out two loans simultaneously: a first mortgage for 80% of the purchase price, and a second mortgage for a lesser amount, typically 10% to 15%.

The “80/15/5” mortgage strategy is a good example. With this approach, the home buyer takes out a first loan equaling 80% of the purchase price, along with a second loan for 15%. The buyer then makes a down payment for the remaining 5%.

• First mortgage: 80%
• Second mortgage: 15%
• Down payment: 5%
• It all adds up to 100%

In this piggyback scenario, neither of the two loans accounts for more than 80% of the home’s value (the usual trigger for PMI). So private mortgage insurance would not be required. But the first-time buyer is still able to make a relatively low down payment of 5%.

Piggyback loans can be more complex and have higher interest rates on the secondary loan compared to the primary mortgage. And qualifying for two loans can be challenging, so good credit and steady income are essential. Still, it’s worth considering.

Bottom line: The piggyback mortgage strategy isn’t for everyone. But some first-time home buyers with conventional loans could benefit from it, by taking PMI out of the picture entirely.

Rules for Cancelling Mortgage Insurance

Earlier, we touched on the different options for canceling mortgage insurance—and in some cases, the lackof options. As a first-time home buyer, you need to understand these rules and procedures, because they can affect you for many years.

The rules for canceling mortgage insurance vary depending on whether it’s a conventional or FHA loan. Here’s how it works…

Rules for FHA Loans

First-time buyers who put down less than 10% on an FHA loan usually have to pay the annual insurance premium for the “life” of the loan (i.e., until they sell or refinance the home).

Buyers who put down 10% or more on an FHA loan can usually cancel the annual mortgage insurance after 11 years. But few people choose this option, because it goes against the program’s main benefit of a low down payment.

Rules for Conventional Loans

Unlike the FHA program, first-time home buyers with private mortgage insurance on a conventional loan can always cancel their PMI—once they’ve built up enough equity.

In this context, “equity” is the difference between the market value of your home and what you still owe on your mortgage. It’s the portion of the home’s value that you truly own.

When you make regular mortgage payments over time, you gradually increase the amount of equity you have in the home. Eventually, this can allow you to cancel PMI.

According to the Consumer Financial Protection Bureau:

“You have the right to ask your servicer to cancel PMI on the date the principal balance of your mortgage is scheduled to fall to 80 percent of the original value of your home. Even if you don’t ask your servicer to cancel PMI, in general, your servicer must automatically terminate PMI on the date when your principal balance is scheduled to reach 78 percent of the original value of your home.”

Disclaimer: Every mortgage lending scenario is different because every borrower is unique. As a result, portions of this guide might not apply to your situation. When buying your first home, be sure to explore all of your financing options to find the best fit. This includes considering the additional cost of mortgage insurance, if applicable.