Mortgage lenders, like companies that make car and credit card loans, take a risk that the person borrowing their money will be unable to repay it.
While mortgage companies use criteria such as credit scores and down payments to determine the likelihood that the borrower will repay the loan, they also use mortgage insurance (MI) to help offset their risk.
Mortgage insurance is required on conventional (Fannie Mae) loans when the down payment is less than 20%. The premium, which is included in your mortgage payment, is based on your down payment. The larger the down payment, the lower the premium because the risk that you may default is lower for the lender. As you approach the minimum down payment of 3%, premiums will increase, as well as credit score requirements.
There will be MI on most FHA loans, regardless of your down payment. On FHA, there are actually two types of MI: One is called the “upfront premium,” which can either be paid out of pocket or financed. The other type of MI is included in your monthly mortgage payment.
The biggest difference in MI between conventional and FHA programs is the way mortgage insurance is removed. On conventional mortgages, if certain criteria are met, MI can be stopped. With many FHA mortgages, the MI will remain on the loan until it is paid off.
While FHA mortgages can be more costly to obtain, and the monthly payment (which includes MI) will be higher, they are often easier to qualify for than conventional loans.