What is Mortgage Insurance? Is it Really That Bad?
Today, it’s easier than ever to find a mortgage with little to no down payment. The tradeoff, however, is that you’ll pay mortgage insurance.
Mortgage insurance has a bad reputation. People hear the term and want to run the other way. But it isn’t as bad as it sounds, and quite honestly, if it helps you buy a home with a lower down payment, it may even be good.
Mortgage insurance helps lenders look at you in a different light. You are no longer as ‘risky’ as they once thought with the guarantee that insurance provides.
Let’s look closer at mortgage insurance, and why it may not be as bad as you think.
What is Mortgage Insurance?
Mortgage insurance premiums are the responsibility of the borrower, but they don’t protect you – they protect the lender.
The policy pays back the lender a portion of the funds lost when borrowers default on a loan. It doesn’t protect you if you lose your job or fall ill – that’s mortgage life insurance and is a completely different product.
Mortgage insurance, also known as PMI (Private Mortgage Insurance) protects the lender from default.
Why is Mortgage Insurance Good?
Insurance costs money, but it protects you, or in this case the lender. In a way, though, it offers you benefits – you can buy a house with little money down.
Think of it this way, if you needed a 20% down payment, it would take you a lot longer to buy a home. If you put 3% down though, you may be able to buy a home sooner, but pay mortgage insurance.
Related: What is Dual Agency and Is It Bad?
Which Loans Charge Mortgage Insurance?
Conventional loans, which are the only non-government loans, charge what they call Private Mortgage Insurance (PMI) when you put less than 20% down. The amount you pay depends on how much you put down and your credit score. The higher your down payment and the higher your credit score, the less you pay.
FHA and USDA loans, which are government-backed, charge mortgage insurance for the life of the loan. But every power pays the same amount. USDA loans charge 0.35% of the outstanding loan amount and FHA loans charge 0.85% of the outstanding loan amount.
VA loans, which are government-backed loans for veterans, don’t charge mortgage insurance. Veterans can get 100% financing without adding to their monthly mortgage payment.
When do you Pay Mortgage Insurance?
You have a few options to pay mortgage insurance, but most people pay it monthly. The insurance companies charge lenders annually, but lenders break up the annual premium into monthly payments for borrowers.
If you have a lump sum of money available (that you don’t want to put toward the home), you can pay the mortgage insurance in one lump sum, but this applies to conventional loans only. This only makes sense if you’ll live in the home for the duration of the term. If you move sooner, you may overpay mortgage insurance when you pay upfront.
How can you Avoid Mortgage Insurance?
If you get government-backed financing, you can’t avoid mortgage insurance, unless you get a VA loan (which is only for veterans).
If you secure conventional financing, though, you may be able to avoid PMI in a few ways:
- Make at least a 20% down payment
- Get a piggyback loan (80% first mortgage, 10% second mortgage, and 10% down payment from your own funds)
- Ask for lender-paid mortgage insurance (some lenders offer this, but in exchange, they charge a higher interest rate)
Can you Eliminate Mortgage Insurance?
Just like you can’t avoid mortgage insurance on government-backed loans, you also can’t eliminate it.
The only mortgage insurance you can eliminate is PMI on a conventional loan. Here are a few ways:
- Request that the lender cancel the insurance when you owe less than 80% of the home’s value as determined by your amortization table
- Order a new appraisal if you think your home value increased enough that you owe less than 80% of the home’s value sooner
- Pay extra toward your loan’s principal to pay the balance down faster and get below the 80% threshold
In any of the three scenarios, you must request that the lender cancel your PMI. They don’t cancel it automatically. It’s up to lender discretion – they look at your payment history to make sure you aren’t a risk of default.
If you made your payments on time, though, most lenders will cancel it early. By law, lenders must automatically cancel PMI once they owe less than 78% of the home’s value, without a borrower’s request.
Is Mortgage Insurance for the Life of the Loan?
If you have a government-backed loan, you have mortgage insurance for the life of the loan. There’s no option to cancel FHA or USDA mortgage insurance. Your only option is to refinance, which is what many borrowers do once they improve their credit and/or lower their debt ratio so they qualify for a conventional loan.
Do you Need Mortgage Insurance?
Many borrowers today have mortgage insurance on their loans. It’s not a ‘bad’ thing. It’s a way to help you become a homeowner faster. If you can improve your financial situation through the years, you can always refinance
For now, though, if you don’t have that 20% down payment, you’ll pay mortgage insurance if you want a loan. Think of it as a way to help you achieve your homeownership dreams faster. It may even push you to improve your credit and/or pay your loan down faster so you can eliminate it, making it a win-win situation.
Have more questions about mortgage insurance? Give us a call at any time!