4 Scenarios When Mortgage Insurance Is Not Required in California

As a California-based mortgage company, we do our best to educate our clients and readers on all aspects of the mortgage loan and home buying process. Today, we will focus on a subject that generates much interest (and some confusion) among home buyers in California. And that’s mortgage insurance.

In this article, we will explore five scenarios where mortgage insurance is not required in California, even when a person uses a home loan to finance the purchase.

What Is Mortgage Insurance, Exactly?

Mortgage insurance is a financial safeguard that lenders often require when borrowers obtain a home loan with a low down payment. This unique kind of insurance protects the lender in case the borrower defaults on the mortgage. It reduces the lender’s risk by ensuring that they will recoup their losses if the borrower fails to make their mortgage payments.

There are two main types of mortgage insurance that are commonly used in the state of California, depending on the type of loan being used:

• Private mortgage insurance (PMI) is used for conventional loans.
• Government-backed FHA loans, on the other hand, require a government-provided mortgage insurance premium (MIP).

Let’s take a closer look at these two variations. After that, we’ll explore five scenarios when mortgage insurance is not required in California.

Private Mortgage Insurance (PMI)

PMI is often required for conventional loans when the loan-to-value (LTV) ratio rises above 80%. That’s why borrowers often have to pay PMI when making a down payment below 20%. In this scenario, the LTV ratio would be above 80% and would therefore trigger the PMI requirement.

By the way: A conventional loan is one that’s not backed by the government. The “conventional” label distinguishes them from government-backed mortgage programs like FHA and VA.

PMI is provided by private insurance companies and paid for by the borrower as part of their monthly mortgage payment. PMI premiums can vary depending on factors like the loan amount, credit score, and down payment size.

The annual premium amount for a California PMI policy is typically expressed as a percentage of the loan amount. According to data from the Urban Institute’s Housing Finance Policy Center, the cost ranges from 0.58% to 1.86% of the loan amount per year, on average.

Borrowers can request the removal of PMI once they reach a specified level of equity in their home, usually 20%. This is a key difference between PMI and FHA mortgage insurance, which we will cover next.

Federal Housing Administration (FHA) Mortgage Insurance

FHA loans are an example of a government-backed mortgage loan. They’re offered by lenders in the private sector, as with most other types of loans. But they also receive federal insurance backing through the FHA, an agency that’s part of HUD.

FHA loans are popular among first-time home buyers in California, as well as borrowers with lower credit scores. Though they’re not limited to those groups.

FHA mortgage insurance comes in two forms: an upfront premium paid at the time of closing, and an annual premium paid as part of the monthly mortgage payment. The upfront premium can also be rolled into the loan and paid off over time.

Most home buyers in California who use FHA loans to buy a house have to pay the annual premium for as long as they keep the loan.

In both of these cases (PMI and FHA), mortgage insurance protects the lender rather than the borrower. But it also offers some major benefits to home buyers in California. It allows borrowers to buy a home sooner rather than later, by allowing them to make a smaller down payment.

Four Scenarios Where It’s Not Needed

Mortgage insurance is not always required. On the contrary, many home buyers in California who use mortgage loans to facilitate their purchases are able to avoid paying mortgage insurance altogether. This in turn reduces the size of their monthly payments.

Here are four scenarios where mortgage insurance is not required in California:

1. Making a down payment of 20% or more

If the borrower can make a down payment of at least 20% on a conventional loan, they can often avoid the need for mortgage insurance. This is because a 20% down payment is considered a strong indicator of financial stability and lowers the lender’s risk. It also keeps the loan-to-value ratio at or below 80%, avoiding the PMI requirement.

2. Using the VA loan program

Many military members and veterans in California are eligible for VA loans, which are guaranteed by the U.S. Department of Veterans Affairs. These loans do not require mortgage insurance, regardless of the down payment amount.

3. Using a USDA “rural” home loan

The U.S. Department of Agriculture (USDA) offers loans for rural home buyers who meet certain income requirements. They’re commonly known as “USDA loans.” These loans also do not require mortgage insurance, making them an attractive option for eligible borrowers.

California home buyers who use USDA loans do have to pay an “annual guarantee fee.” But this fee usually costs a lot less than the private mortgage insurance assigned to conventional loans.

As it states on the USDA.gov website:

“USDA Rural Development (RD) Single-Family Housing Direct loans have no private mortgage insurance. USDA Guaranteed Loans are charged an annual guarantee fee instead of mortgage insurance. Guarantee fees are paid to USDA by the approved lender and are usually included in the homeowner’s monthly loan payment.”

In most cases, the USDA annual fee amounts to 0.35% of the outstanding mortgage balance, divided into 12 monthly payments.

The bottom line here is that standard mortgage insurance is not required for USDA home loans in California.

4. Combining two mortgage loans in a “piggyback” fashion

Some borrowers choose to combine a first mortgage and a second mortgage (known as a piggyback loan) to avoid paying mortgage insurance.

For example, a home buyer could make a 10% down payment, take out an 80% first mortgage, and a 10% second mortgage, effectively avoiding mortgage insurance. In this scenario, neither of the two loans would have an LTV above 80%. So mortgage insurance would not be required.