When purchasing a home, many buyers find themselves faced with the need for mortgage insurance, a type of financial protection that lenders require when borrowers make a down payment of less than 20% of the home’s purchase price. Let’s dive into the basics of what it is, different types, costs, and how it impacts homebuyers.
What Is Mortgage Insurance?
Mortgage insurance is a policy that protects lenders against the risk of borrowers defaulting on payments and going into foreclosure. While it doesn’t provide any direct benefits to the homebuyer, it allows borrowers to obtain a mortgage with a smaller down payment, as it mitigates the lender’s risk. Keep in mind that just because you’re paying insurance, it doesn’t mean it covers the entirety of the lender’s cost.
Types of Mortgage Insurance
Private Mortgage Insurance (PMI)
PMI is the most common type of mortgage insurance and is typically required for conventional loans. It is provided by private insurance companies and can be paid monthly, as a lump sum upfront, or a combination of both. Lenders will shop around so the borrower can pay a cheaper price, but generally, private companies offer similar costs.
Federal Housing Administration (FHA)
FHA loans, which are insured by the government, require borrowers to pay an upfront mortgage insurance premium (MIP) at closing, along with an annual premium that is paid monthly. This is a standardized option that is generally more expensive than conventional insurance, as it goes for the entirety of the loan.
Department of Veterans Affairs (VA) Funding Fee
For eligible veterans, active-duty service members, and sometimes spouses, VA loans do not require mortgage insurance. However, they impose a one-time funding fee that helps offset the costs of the VA loan program. The VA also helps cover the cost of other home buying fees, including hiring an attorney or real estate agent.
Insurance Costs
The cost of mortgage insurance offered to borrowers will vary depending on factors such as the loan type, down payment amount, credit score, and debt-to-income ratio. Usually, the higher the down payment and credit score, the lower the insurance premium.
How Does It Impact Homebuyers?
Mortgage insurance allows homebuyers to purchase a property with a smaller down payment, making homeownership more accessible. This is good news, especially for first-time buyers or people with limited savings. Additionally, the insurance is added to the borrower’s monthly payment, increasing the overall amount. However, PMI can be canceled once the loan-to-value ratio reaches 78%, based upon the original value of the home. Finally, lenders often require mortgage insurance for home loans with smaller down payments. It’s important for homebuyers to understand the impact of insurance costs on their overall mortgage pre-approval process.
Can Homebuyers Avoid Paying for It?
In most cases, it’s possible for homebuyers to avoid mortgage insurance if they can make a 20% down payment. Additionally, down the road, you can ask a lender if you can get a new appraisal and have it removed, but keep in mind that sometimes it makes more sense to continue paying for the insurance rather than paying for a new appraisal.
Final Thoughts
Mortgage insurance is a vital component of the home buying process for those who cannot make a 20% down payment. It provides an opportunity for individuals to enter the housing market with a smaller upfront investment, but insurance can become a large percentage of mortgage payments. We encourage borrowers to carefully consider the long-term implications of mortgage insurance before purchasing a home. Working closely with a lender is best, as homebuyers will be better equipped to make informed decisions that best align with their financial goals.
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