Buying a home is an exciting milestone, but also a complex financial move. Mortgages make homeownership affordable by allowing you to finance the purchase price over time. With so many mortgage options out there, it can be confusing to understand the requirements around mortgage insurance. Do conventional loans require mortgage insurance? How does it work? Let’s take a closer look.
What is Mortgage Insurance?
Mortgage insurance, also called MI or PMI (private mortgage insurance), is an additional policy that protects the lender in case you default on mortgage payments. It is typically required when borrowers make a down payment of less than 20% of the home’s value.
Since the down payment is lower, there is initially less equity built up in the home. Mortgage insurance reduces the lender’s financial risk until the equity increases to 20% through mortgage payments.
The policy is purchased upfront at closing and results in an additional monthly fee tacked on to mortgage payments until MI can be removed. Monthly MI premiums range from 0.3% – 2% of the total loan amount.
Do Conventional Loans Require Mortgage Insurance?
Conventional loans are mortgages that conform to standards for loan limits and down payments as set by Fannie Mae and Freddie Mac. They are offered by private lenders like banks and credit unions.
Whether mortgage insurance is required on a conventional loan depends on the size of your down payment:
- Less than 20% down: MI is required and monthly fees apply until you reach 20% equity.
- 20% or more down: No mortgage insurance required.
So if you make at least a 20% down payment on a conventional loan, you can avoid paying monthly MI premiums altogether. But anything less than 20% down triggers the MI requirement until you build 20% home equity through payments.
When Can Mortgage Insurance be Removed?
On conventional loans, here are some common scenarios for removing MI requirements:
- Reaching 20% equity through mortgage payments over time.
- Paying down the balance to hit 78% loan-to-value ratio through extra payments.
- Refinancing into a new loan with at least 20% equity.
- Requesting cancellation once equity reaches 20% based on current home value.
Always check your loan terms to understand the guidelines for canceling mortgage insurance. Many lenders allow you to request removal once hitting 20% equity.
Key Benefits of 20% Down on a Conventional Loan
While paying 20% down is a major upfront cost, it comes with big benefits:
- No mortgage insurance required, saving substantially on monthly payments.
- Better interest rates and overall loan terms.
- More equity built up from the start.
- Options to remove PMI immediately after closing.
- Greater protection against home price declines and negative equity.
Building savings for a 20% down payment takes diligence but pays off over the long run.
Alternatives to Conventional Loans
Two alternatives that take a different approach to mortgage insurance are FHA and VA loans:
- FHA loans require MI no matter the down payment size. However, monthly premiums are lower and can be cancelled once hitting 78% loan-to-value.
- VA loans for veterans waive mortgage insurance requirements altogether. No MI payments needed regardless of down payment.
These options provide more flexibility if you don’t have a full 20% down payment.
Shop Multiple Loan Types
Each loan program – conventional, FHA, VA, USDA – has its own policies around down payments, mortgage insurance, rates, and approval requirements. To find your best option, shop multiple loan types from different lenders. Look closely at both upfront and monthly costs. Doing the math will reveal which mortgage lender structure best fits your financial situation.
Conclusion
On conventional loans from private lenders, making at least a 20% down payment is the only way to avoid mandatory mortgage insurance and those costly monthly premiums. But FHA and VA loans take a different approach if you don’t have 20% down. Be sure to explore all your mortgage alternatives side-by-side to make an informed decision based on both short and long term costs. This will ensure you choose optimal home financing.
