Mortgage default insurance (MDI) is an insurance policy that safeguards the lender by covering losses if a borrower fails to make mortgage payments. Although the borrower pays the premium, the protection benefits the lender, not the homeowner. This insurance is generally mandatory for conventional loans when the down payment is less than 20%, reducing lender risk and enabling access to financing for buyers without large down payments.
Think of MDI as a financial safety net for lenders. Borrowers pay the premiums, typically included in the monthly mortgage payment, but the coverage only activates if the borrower defaults. This arrangement allows lenders to offer loans to more buyers, expanding homeownership opportunities.
How Mortgage Default Insurance Works
Lenders require a 20% down payment to minimize risk—larger down payments mean borrowers have more equity and are less likely to default. When buyers put down less than 20%, lenders must protect themselves with mortgage default insurance. The premium usually adds to the monthly mortgage payment, which often includes principal, interest, property taxes, and insurance (PITI).
Types of Mortgage Default Insurance
Different loan programs use specific forms of mortgage default insurance:
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Private Mortgage Insurance (PMI): Applied to conventional loans, PMI can be canceled once the borrower reaches 20% equity in the home. More details at our Private Mortgage Insurance (PMI) page.
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Mortgage Insurance Premium (MIP): Required for FHA loans, MIP includes an upfront fee rolled into the loan and ongoing monthly premiums, usually lasting the life of the loan unless significant down payment thresholds are met. Learn more at Mortgage Insurance Premium (MIP).
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VA Funding Fee: An upfront fee for VA loans that helps sustain the VA loan program, distinct from monthly insurance premiums. See VA Funding Fee.
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USDA Guarantee Fee: Includes an upfront fee plus an annual fee for USDA loans, supporting this government-backed program.
How to Cancel PMI
For conventional loans with PMI, borrowers can cancel it in these ways:
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Requested Cancellation: When the mortgage balance reaches 80% of the home’s original value, borrowers can request PMI cancellation, often requiring a good payment history and sometimes a home appraisal.
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Automatic Termination: By law (Homeowners Protection Act), PMI must be canceled once the loan balance hits 78% of the original home value if payments are current.
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Refinancing: If the home’s market value increases significantly, refinancing to a conventional loan without PMI may be possible.
Common Misunderstandings
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Mortgage default insurance protects the lender, not the borrower. It doesn’t cover unpaid mortgage payments due to job loss or disability; separate mortgage protection insurance exists for that.
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PMI and other default insurances are legitimate costs to enable lower down payment loans, not scams or unnecessary fees.
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Different loans have different insurance types and cancellation rules. Understanding these differences helps make better financing decisions.
Mortgage default insurance plays a critical role in lending, opening homeownership opportunities but adding a temporary cost. By understanding how it works and your options for cancellation, you can better manage your mortgage expenses and plan for a future without mortgage insurance costs.
For more on related mortgage topics, visit Mortgage Loan, FHA Loan, and Conventional Mortgage.
References:
Consumer Financial Protection Bureau, “What is Private Mortgage Insurance?” https://www.consumerfinance.gov/ask-cfpb/what-is-private-mortgage-insurance-en-122/
Investopedia, “Private Mortgage Insurance (PMI)” https://www.investopedia.com/terms/p/pmi.asp