Buying a home is an important milestone in anyone’s life. However, there are several costs associated with buying a home. One of the most important expenses you may have to pay is mortgage insurance. Mortgage insurance is required of homebuyers if they make a down payment of less than 20% of home value. For example, if your down payment on a $ 300,000 home is less than $ 60,000 ($ 300,000 x 20%), you will need to get mortgage insurance.
The lender requires mortgage insurance as there is a risk that you will borrow more than 20% of the home value. Insurance protects the lender if the homeowner defaults on their payments. What are the costs, the duration of payments and, most importantly, the different types of mortgage insurance?
What does mortgage insurance cost?
The most common type of mortgage insurance is private mortgage insurance (PMI). PMI can range from 0.4% – 2.25% of the loan amount. For example, if you have a $ 400,000 loan, the PMI can range from $ 1,600 to $ 9,000. So what determines whether you will get a low or a higher PMI rate:
- Loan amount – A higher loan amount will require a higher PMI rate due to the added risk to the lender. Therefore, a $ 700,000 mortgage has a higher PMI than a $ 300,000 mortgage.
- deposit – Lenders prefer a higher down payment as it shows that the borrower has funds available to increase their home ownership. A higher deposit will result in a lower PMI rate.
- Credit score – Creditworthiness is very important in all credit decisions. A higher credit score shows the lender that you are more creditworthy and more likely to pay back your debts.
- Mortgage type – The PMI rate is higher for variable rate mortgages than fixed rate mortgages because the monthly mortgage payment amount is uncertain.
How long do I have to pay for mortgage insurance?
Mortgage insurance is required for home loans where the down payment is less than 20% of the loan. Therefore, PMI can be canceled when you reach 20% home ownership. Therefore, the insurance does not last for the term of the loan, but can be removed in an average of 6 years, depending on the amount of the initial down payment.
What are the different types of mortgage insurance?
There are four different types of mortgage insurance:
- Borrower Paid Mortgage Insurance (BPMI) – This is the most common type of insurance. With this form of insurance, the premium is added to your monthly mortgage payment, making it higher every month. Once you have 20% home ownership, you can contact the lender and cancel them. You can also get rid of PMI if you refinance and have a smaller loan amount.
- Single Premium Mortgage Insurance (SPMI) – With this form of insurance, the insurance is paid out in advance in a lump sum instead of increasing your monthly mortgage payment. This can be a good strategy if you want smaller monthly mortgage payments. However, these funds can also help increase your down payment.
- Mortgage Insurance Paid by Lender (LPMI) – Now, while it sounds great that the lender is paying for the insurance, the payment will eventually be passed on to you in the form of a higher mortgage rate. Therefore, if you choose this option, instead of paying for PMI, you will pay higher interest over the life of the loan. Over time, this option becomes disadvantageous compared to the other options. Therefore, it is advisable not to select this option.
- Split premium mortgage insurance – This type of insurance is a combination of BPMI and SPMI where instead of adding the entire amount to your monthly mortgage payment, you pay part of it upfront and the rest is added to your mortgage payment. That way, you don’t need a very large upfront payment and your mortgage is manageable.
How do I avoid private mortgage insurance?
Well, that is an important question, nobody wants to pay for insurance if they are not benefiting from it. There are three ways not to pay for insurance:
- Down payment greater than 20% – Well, this is straightforward. A larger deposit might not mean a PMI. So if you can borrow money or save longer, you can avoid PMI.
- USDA loans – – USDA loan is a government insured loan that does not require a PMI. Instead, there are other rules and permissions that must be met.
- VA loan – – VA loan is a mortgage for veterans. If you are a veteran you can get VA loan without the need for a PMI!
In conclusion, insurance can be an annoying extra payment to make. However, it is useful as it allows lenders to provide mortgages to people who cannot afford the full 20% down payment. Try your best to save enough money to avoid paying for mortgage insurance. Most importantly, make sure to get rid of PMI when you hit 20% home ownership!