Mortgage insurance is required for most home loans that don’t have at least a 20 percent down payment. When financing a mortgage, having a financial stake in the home makes buyers less likely to default. But for some mortgage seekers, a substantial down payment isn’t realistic.
Before you become a homeowner, check out this list of things that you should know about insuring a home.
Click through to find answers to important mortgage questions.
1. What Mortgage Insurance Means
What is mortgage insurance? Mortgage insurance is a policy that compensates lenders for losses due to the default of a mortgage loan. Mortgage home loan insurance guarantees the lender will be repaid if the buyer stops making payments on a home loan.
“Reducing the lender’s risk makes it possible for homebuyers to get into a home with less than 20 percent down, which promotes homeownership nationwide,” said Dan Green, founder of mortgage education website Growella and a former top-producing loan officer.
2. Who Should Get Mortgage Insurance
Mortgage insurance is available for government-backed home loans as well as conventional loans. Typically, if you make a down payment of less than 20 percent of the purchase price of the home, you’ll need to pay for mortgage insurance, according to the Consumer Financial Protection Bureau. Mortgage insurance also is usually required on a loan from the Federal Housing Administration or the U.S. Department of Agriculture.
3. What Private Mortgage Insurance Means
One type of mortgage insurance is private mortgage insurance. PMI is what you’ll have to pay if you have a conventional loan. That said, a buyer can’t shop around for PMI.
“The lender chooses the mortgage insurance company that is used,” said Joe Talmadge, vice president of mortgage lending for Northwest Federal Credit Union in Herndon, Va.
4. How Much PMI Costs
Generally speaking, you can expect to pay a monthly premium equaling $30 to $70 for every $100,000 you borrow, according to Freddie Mac. Your lender is required to disclose your exact PMI mortgage insurance costs, but many are based on factors such as:
– Where you live
– Type of property you’re buying
– Loan term and amount
– Loan-to-value ratio
– Credit history
5. Who PMI Protects
You purchase private mortgage insurance for your lender, to reimburse it in the event the lender has to foreclose on your home and sell it at a loss. “Lenders are not in the business of owning homes, but that’s what happens when a home is foreclosed upon. The policy kicks in if you default on your loan and repays the lender for its losses,” said Green.
6. What Mortgage Insurance Doesn’t Cover
You’ll need mortgage protection insurance to cover your mortgage payments if you’re unable to pay because of disability, job loss or death. This credit life and disability — or mortgage disability — insurance can stand alone or be combined with mortgage life insurance to protect your assets after job loss.
7. How Mortgage Insurance Benefits Buyers
Your lender’s mortgage insurance benefits you even though it doesn’t cover your losses.
“The insurance fills the gap between the sales price/home value and the standard 20 percent down requirement, which allows the borrower to come up with less out of pocket,” said Talmadge. “This makes the process of buying a home more affordable for many buyers and might help them become a homeowner sooner. It also increases their buying power and broadens their options.”
8. How to Make Mortgage Insurance Payments
Although you pay the upfront fees at closing or finance them as part of your mortgage loan, you’ll probably make your monthly payments with your regular mortgage loan payment. The payment amount shown on your payment coupons typically includes the premium, and the lender pays the insurer directly.
9. How Long You Have to Pay PMI
You can cancel PMI once you’ve built enough equity in your home. “Borrowers can also request to cancel PMI once the unpaid principal balance reaches 80 percent of the original value,” Talmadge said.
Find Out: How to Get Rid of PMI
10. Who Can Avoid Mortgage Insurance
Although there are benefits to mortgage insurance, having it adds to the cost of getting a home loan. The following alternatives to mortgage insurance can help you cut costs even with less than 20 percent down:
– Pay a higher interest rate. Some lenders might waive PMI in exchange for charging a higher interest rate.
– Get a piggyback loan. These home equity loans or credit lines let you borrow your down payment money. Review the fine print carefully to see if the total monthly cost is actually cheaper than paying for mortgage insurance.
– Consider a non-conforming loan. A non-conforming conventional loan doesn’t require mortgage insurance, even with less than 20 percent down. “These are often referred to as portfolio loans, and each bank will have its own requirements or restrictions, but they often require higher credit scores, more assets in the bank, cleaner credit profiles and larger loan amounts,” said Michael Power, branch manager of BBMC Mortgage in Schaumburg, Ill.
11. How Insurance Works for Government-Backed Loans
FHA, USDA and VA loans all require premium payments. The premium for FHA loans is for mortgage insurance. USDA and VA loans are guaranteed loans, not insured ones, but their fees work in much the same way — the lender will add an upfront payment to your closing costs. With an FHA or USDA loan, you’ll also pay a monthly fee.
12. How Much the FHA Mortgage Insurance Premium Will Cost You
Premiums are the same for everyone regardless of credit score — but you’ll pay a little more if your down payment is less than 5 percent. An upfront fee of 1.75 percent of your loan amount is due at closing, and you’ll pay a monthly premium of 0.80 percent to 1.05 percent, depending on your down payment.
On That Note: What Is an FHA Loan?
13. When to Pay the USDA Rural Development Guarantee Fee
The Rural Development guarantee fee is like FHA mortgage insurance, but less expensive. You’ll make an upfront payment of 1 percent of the loan amount, and then pay 0.35 percent of your average principal balance for the life of the loan.
14. How Much You’ll Be Charged for VA Loan Fees
The fee associated with a VA guaranteed loan is called a funding fee. The amount depends on factors like your military service type, down payment amount, disability eligibility and whether you’ve had a previous VA loan. Regular military personnel using a VA loan for the first time pay from 1.25 percent to 2.15 percent, depending on their down payment.
15. How to Weigh the Costs and Benefits
Mortgage insurance isn’t a bad thing. If it lets you build equity rather than pay rent, mortgage insurance can actually save you money. Saving up for a big down payment for a conventional loan can get you a lower interest rate and eliminate the extra expense of mortgage insurance.
Run the numbers using an online mortgage insurance calculator and compare current interest rates. Then, talk to your lender to decide which option is best for you. Talking to your lender won’t answer every question you still have about mortgage insurance, but it’s certainly the next best step.
Cynthia Measom contributed to the reporting for this article.