Ah, yes, mortgage insurance! Once you start considering buying a home you’ll discover all sorts of “fees” you had no idea existed. “Don’t I just put down some money, get a mortgage and they hand me the keys?” For example, you have to pay for the lender’s appraisal and property inspection, escrow fees and title insurance fees, pre-paid taxes and interest. All the more reason you need to find yourself a good mortgage broker who will explain the mortgage process and the pros and cons of different types of mortgages.
And then we have the least loved of them all….mortgage insurance! Unless you have a down-payment of 20% or more or qualify for a Veterans Administration (VA) loan, then you are going to have to pay mortgage insurance.
So, what is mortgage insurance? Mortgage insurance is insurance that you pay on behalf of the lender to cover against the possibility that you might default on your loan and the lender has to repossess your home and try recoup their losses by reselling the home. The bigger the down payment you make on a home, the less of a risk you are perceived to be by the lender.
There are two types of mortgage insurance
Private mortgage insurance (PMI) is required for all conventional loans (those underwritten by Fannie Mae and Freddie Mac) where the borrower is putting down less than 20%. Currently you pay $78 per month per $100,000 you borrow. The bigger your down-payment, the less PMI your pay, based on 5% increments.
Monthly Insurance (MI) is the insurance you pay when you take out a Federal Housing Authority (FHA) loan. These loans allow you put to down only 3.5% and are very popular with many first time home buyers who don’t have large down-payments saved up. Also, buyers with less than perfect credit may quality for a FHA loan as do those with higher debt-to-income ratios. Currently you will pay $102 per month per $100,000 you borrow. However, the MI rate is the same even if you make a bigger down-payment.
So, how do I avoid paying mortgage insurance or get rid of my existing mortgage insurance?
For Private Mortgage Insurance (PMI):
- When buying a home and applying for mortgage, put at least 20% down
- Once you have paid down the original mortgage amount by 20% your PMI should automatically be eliminated (but make sure your lender does so)
- If the market value of your home appreciated so that now you have at least 20% equity, your PMI should be dropped. You would have to pay for an appraisal to convince the lender.
For Monthly Insurance (MI):
- The only way to avoid PI on an FHA loan is to put down at least 22% and get a fixed rate 15 year loan. Even with a 22% down-payment for a 30 year fixed rate loan, you would still have to pay MI.
- The home owner with a FHA loan must pay MI for at least 5 years AND pay down the loan to 78% of the original loan amount before MI will be dropped. Theoretically, even if the market value of your home doubled in the first 2 years you owned it, you would still have to pay MI for 3 more years!
- So why would anyone who could afford to make a sizable down-payment apply for a FHA loan? Well, because their credit history may not be good enough to qualify for a more stringent conventional loan.
If you have been a member of the armed forces then you may qualify for a VA loan and you won’t have worry about mortgage insurance. You deserve it!