Some buyers are able to make a significant down payment on a home, but for the majority, hitting that targeted 20 percent isn’t realistic. Fortunately, mortgage insurance makes it possible for those who can’t afford the “standard” down payment to still fulfill their homeownership dreams.
Here’s a little more about what it is, how it works, and when it’s required.
What is mortgage insurance?
When you think of insurance regarding a home, homeowners insurance likely comes to mind. However, homeowners insurance and mortgage insurance are quite different.
Homeowners insurance provides financial protection for your home and personal belongings from damage or theft. While it isn’t legally required, mortgage lenders typically require that borrowers purchase a policy as terms of a mortgage. Coverage specifications may vary by lender.
Mortgage insurance, on the other hand, protects the lender, not the borrower. The less a borrower puts down, the riskier they appear to a lender. Mortgage insurance makes it possible for buyers to hand over a much smaller down payment and still qualify for a loan. It protects the lender or bank should the borrower default or become unable to pay off the loan for whatever reason.
How does it work with conventional loans?
If you’re putting less than 20 percent down on a conventional loan, your lender will require you to purchase private mortgage insurance (PMI).
Wayne Lacy, branch manager with Cherry Creek Mortgage Company in Okemos, says PMI can be paid in three different ways.
“The traditional method is through a monthly premium, but it can also be paid up front in one lump sum at closing, or a borrower can possibly remove it from the loan by increasing their interest rate to cover the premium,” he said.
Lacy says how PMI is paid is an important consideration, especially in today’s environment, and he suggests speaking with a local, experienced lender to help ensure you’re making a sound financial decision.
“Right now, we are closing at such low interest rates, borrowers may want to consider taking a bit higher rate and paying off PMI up front,” he said. “That way you can lock in a low rate and not worry about paying a monthly premium or refinancing two years down the road for a higher rate, or possibly the same rate, but with closing costs.”
The amount each borrower pays for PMI is calculated based on risk. Lenders look at an individual’s down payment, credit score, and debt-to-income ratio to determine specific rates.
Your loan amortization schedule lists the date when the insurance will be cancelled, which is typically when a borrower reaches 22 percent equity, or 78 percent loan-to-value.
“You can request to cancel PMI earlier if you’ve made additional payments that reduce the principal balance of your mortgage to 80 percent loan-to-value,” said Lacy. “But whether or not it’s removed is up to the lender’s discretion, and they may require an appraisal to prove the value of the property hasn’t declined below the original value of the home.”
How does it work with government-backed loans?
These loans require what is referred to as a mortgage insurance premium, or MIP.
While PMI is risk-based, MIP is a flat rate based on the loan amount. For FHA loans, borrowers pay 1.75 percent of loan amount up front (financed into the loan) and .85 percent monthly. On Rural Development loans, 1 percent is paid up front (also financed into the loan) and .35 percent is paid monthly. Unlike conventional loans, mortgage insurance on government-backed loans is required for the life of the loan.
“VA loans are a little bit different,” said Lacy. “If a veteran is not exempt from mortgage insurance, they will pay a one-time, up-front fee that is financed into the loan. For a no-down-payment loan, it’s 2.3 percent of the total loan amount for first-time buyers, and 3.6 percent for subsequent use.”
If you are considering buying a home and would like more information, set up a consultation with an area lender to discuss your options. For a list of local professionals, visit the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.
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