There’s a lot to consider when purchasing a home. Location, size, and cost spring to mind as three of the most important factors. Perhaps you’ve budgeted and figured out how much you can afford for a down payment, but have you also considered your total monthly mortgage payments?
If you’re applying for a mortgage and can’t afford to put at least 20% down, you may have to pay for mortgage insurance.
What is mortgage insurance?
Mortgage insurance helps protect the lender’s investment, not the homeowner.
A homeowner’s insurance policy may reimburse you for a variety of expenses, including vandalism, thefts, and environmental damage to your home. Mortgage insurance is a bit different. Although you are responsible for mortgage insurance premiums, the policy protects the lender.
Casey Fleming, mortgage adviser and author of “The Loan Guide: How to Get the Best Possible Mortgage,” explains mortgage insurance “insures the lender against principal loss in the event you default, they foreclose, and the foreclosure sale doesn’t bring in enough money to cover what they’ve lent you.” In short, if you don’t pay your bills, the insurance company will help make the lender whole.
The 20% down payment rule
Mortgage insurance isn’t required for all homebuyers. “Typically, homebuyers looking to get a conventional mortgage must pay PMI if they are making a down payment of less than 20%,” says Josh Brown of the Ark Law Group in Bellevue, Wash., which specializes in bankruptcy and foreclosures. Brown points out PMI serves a valuable function by allowing otherwise qualified homebuyers (with an acceptable debt-to-income ratio and credit score) to be approved for a conventional loan without the need for a large down payment.
How to find mortgage insurance
Mortgage lenders will often find a PMI policy for you and package it with your mortgage. You will have a chance to review your PMI premiums on your Loan Estimate and Closing Disclosure forms before signing paperwork and agreeing to the mortgage.
Types of mortgage insurance
There are two main types of mortgage insurance: Private mortgage insurance (PMI) and mortgage insurance premium (MIP).
PMI helps protect lenders that issue conventional, Fannie Mae and Freddie Mac-backed, mortgages. You’ll often be required to make monthly PMI payments, a large upfront payment at closing, or a combination of the two. These payments are made to a private insurance company and are required unless you have at least 20% equity in your home. You may request to cancel your PMI once you have paid down the principal balance of your home to below 80% of the original value.
Mortgages issued through the Federal Housing Administration (FHA) loan program also require mortgage insurance in the form of a mortgage insurance premium (MIP). You will be required to pay an upfront fee at closing and an MIP every month as part of your monthly mortgage payment. Your MIPs depend on when your mortgage was finalized and your total down payment.
How much mortgage insurance will cost you
PMI premiums can vary depending on the insurer, your loan terms, your credit score, and your down payment. The premiums often range from $30 to $70 per month for every $100,000 you have borrowed, according to Zillow.
Many homeowners’ monthly mortgage payments include their PMI premium. Alternatively, you might be able to make a one-time upfront PMI payment. Or, you could make a smaller upfront payment and monthly payments.
As we mentioned earlier, for an FHA loan, you will have to pay upfront mortgage insurance premium (UFMIP) which is generally 1.75% of your loan’s value. You may have the option of rolling this premium payment into your mortgage and pay it off over time. Your MIP depends on your down payment, the base loan amount, and the term of the mortgage and can range from .45% to 1.05% of the loan’s value. The MIPs must be paid monthly.
Mortgage insurance doesn’t have to be forever
There are a few situations when you may be able to stop making mortgage insurance premium payments.
There are two eligibility requirements for conventional mortgages closed after July 29, 1999. As long as you’re current on your payments, PMI will be terminated:
- On the date when your loan-to-value is scheduled to fall below 78% of the home’s original value.
- When you’re halfway through your loan’s amortization schedule; 15 years into a 30-year mortgage, for example.
Your home’s original value is often the lower of the purchase price or appraised value. The current value of your home and your current loan-to-value aren’t figured into the above criteria.
You can also submit a written request asking your lender to cancel your PMI:
- On the date your loan-to-value is scheduled to fall below 80% of the home’s original value.
- If your current loan-to-value ratio is lower than 80%, perhaps due to rising home prices in your area or renovations you’ve done.
- After refinancing your mortgage once you have at least 20% equity in the home.
Unlike PMI, if you have an FHA loan, your MIP may not ever be removed. The date your mortgage was finalized and the amount you put down determines your eligibility:
- The MIP stays for the life of the loan for mortgages closed between July 1991 and December 2000.
- The MIP will be canceled once your loan-to-value is 78%, if you applied for the mortgage between January 2001 and June 2013, and you’ve owned the home for five or more years.
- If you applied after June 2013 and put at least 10% down, the MIP will be canceled after 11 years. If you put less than 10% down, the MIP stays for the life of the loan.
Refinancing an FHA loan to a conventional mortgage may provide you with additional options.
The pros and cons
There are a variety of pros and cons to consider when weighing the options of waiting to save a 20% down payment versus paying mortgage insurance.
Melanie Russell, a mortgage loan officer in Henderson, Nev., points out buying now can make sense if you expect home prices to increase or interest rates to climb.
What about waiting? In addition to avoiding mortgage insurance, putting more money down could lead to lower closing costs and a lower interest rate on your mortgage. Also, if you expect prices to drop, you’re saving on all the costs that could come with ownership, including taxes, mortgage, insurance, maintenance, and potential homeowners’ association fees.
In the end, it’s often a situational and personal choice. While Russell shared a few positives to buying early and paying for PMI, she also notes, “Only you can answer this question for yourself.”
When you don’t need mortgage insurance
There are also a few options that don’t require mortgage insurance, even if you can’t afford a 20% down payment.
For example, Veterans Affairs (VA) loans, offered to qualified veterans, don’t require mortgage insurance. You might not have to put any money down either, but these loans usually require an upfront payment at closing.
The Affordable Loan Solution program offered through a partnership between Bank of America, Freddie Mac, and the Self-Help Ventures Fund allows borrowers to put as little as 3% down without taking on PMI. Maximum income and loan amount limit requirements may apply.
You may also find some lenders willing to offer lender-paid mortgage insurance. You’ll pay a higher interest rate on the loan, but in exchange, the lender will make the insurance payments for you. “The math works differently every time,” says Fleming. “If a borrower thinks they won’t be in the property very long, [lender-paid mortgage insurance] might be a good choice, as sometimes the additional amount you pay is lower this way.”
However, if you’re in the home and paying off the mortgage for a long time, it could be more expensive than taking out a conventional loan with PMI. Because the premiums are built into your mortgage, you won’t be able to get rid of the extra payments after building equity in the home.
Another option could be to take out a second loan, called a piggyback mortgage. Although there are potential downsides to this route, you can use the money from the second loan to afford a 20% down payment and avoid PMI. Some people also borrow money from friends or family to afford a 20% down payment, but that could put your relationship in jeopardy if you run into financial trouble.
Finally, you might also discover lenders offering no-mortgage-insurance loans with a 10% to 15% down payment. As with the lender-paid mortgages, it’s important to review the fine print and the potential pros and cons of the arrangement.
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