What is mortgage insurance and how does it work?

Mortgage Insurance—also referred to as Private Mortgage Insurance or PMI—offers protection for a lender in case a mortgage payment is missed. Borrowers are typically required to pay mortgage insurance if they are making a down payment of less than 20 percent of a home’s purchase price, however it is also required for some federal loans.

Although mortgage insurance increases the overall cost of your loan, it can sometimes allow you to qualify for loans that you may not be able to secure otherwise.

In effect, mortgage insurance lowers a lender’s risk in the event that they offer you a conventional loan. When you are granted a mortgage loan but you subsequently falter on your payments, then mortgage insurance would ensure your lender is still paid. Failure to pay your mortgage payments in full would still bring consequences to you like a lowered credit score and even foreclosure on your home, but your lender would still receive insurance payments for what you owed them.

This type of protection for lenders means that borrowers with insufficient financial standing—like those with poor credit or not enough funds for a 20 percent down payment—can secure loans where they may otherwise be considered too high risk.

There are four main types of mortgage insurance:

• Borrower-paid mortgage insurance: The most common type, this insurance is included in your monthly mortgage payment.
• Single-premium mortgage insurance: A lump sum insurance payment.
• Lender-paid mortgage insurance: This insurance is technically paid by the lender, but results in higher interest rates for the borrower.
• Split-premium mortgage insurance: This insurance combines a partial lump sum payment upfront and reduced monthly payments.

You can typically avoid having to pay for mortgage insurance by paying at least 20 percent of a home’s cost as a down payment. Some private lenders offer loans with down payments under 20 percent, which also don’t require mortgage insurance—but these usually come with higher interest rates to balance out the heightened risk for the lender.

If you already pay mortgage insurance, you can sometimes eliminate these payments over time by refinancing your loan. Or, you may request the PMI be dropped by your lender when your mortgage loan balance is less than 80 percent of your home’s original value.