What to Know About Mortgage Insurance
If you’re like most people, your greatest concern when buying a home isn’t the monthly mortgage payment. It’s having enough saved for a down payment.
Many homebuyers assume you need to have a down payment equal to 20% of the home’s value. That’s not the case. Yes, there are benefits to putting down that large amount upfront, but if you can’t afford that, you may still qualify for a home mortgage thanks to something called mortgage insurance.
- If your down payment is less than 20% of the home’s value, you may have to pay mortgage insurance.
- Premiums range from 0.2% of the loan amount to more than 1%.
- There are different types of mortgage insurance, depending on the loan you choose.
What is mortgage insurance?
When you put 20% down on a home, you don’t have to borrow as much from a lender. That sizeable investment gives a lender more confidence that you won’t default on the loan.
When you put less money down, the lender takes on more risk. To offset that risk, lenders may require mortgage insurance, which protects them from loss in case you can’t keep up with your payments.
How much does it cost?
Annual mortgage insurance premiums can range from about 0.2% to more than 1% of the total loan amount. The cost will vary based on several factors, including:
- Type of loan
- Loan-to-value ratio
- Your credit score
You’ll typically pay the annual premium in equal installments, which are collected with your monthly mortgage payment.
Are there different types of mortgage insurance?
Yes, but lenders may not offer all options, and some types may be specific to a certain loan programs. Two common types of mortgage insurance are Private Mortgage Insurance (PMI) and Mortgage Insurance Premium (MIP).
There are two PMI options:
- Borrower Paid Mortgage Insurance (BPMI):You’ll pay your premium monthly as part of your mortgage payment. Once you have 22% equity in your home — that is, your loan’s principal balance is 78% of the home’s value — your lender will typically perform an automatic review to determine if the BPMI policy can be cancelled. There may be other instances when you can request an earlier cancellation. Check with your lender for those specific details.
- Lender Paid Mortgage Insurance (LPMI):Your lender pays the total insurance premium upfront, passing the cost onto you through a higher interest rate on your loan. The interest rate increase is often in the range of 0.25% to 0.5%. In addition, LPMI can’t be cancelled. However, since you pay for LPMI as mortgage interest, it may be tax-deductible. Consult your tax advisor for details.
If you take out a Federal Housing Administration (FHA) loan, you’ll pay an MIP, meaning your premiums will go to the FHA rather than a private insurer. Typically with an FHA loan, you’ll pay an upfront MIP premium at closing, as well as monthly MIP payments for the life of the loan.
The bottom line
Saving for a 20% down payment can be difficult. While mortgage insurance is an extra monthly cost, it can help you move into your dream home sooner than you expected. Take this into consideration when you’re saving for your home and deciding on your price range.