Image courtesy of Flickr, David Hilowitz
Whether or not you choose to utilize it, understanding mortgage insurance is vital for anyone buying a home or refinancing an existing home loan.
Purchasing a home is a big deal. Depending on where and what type of house you are buying, you may wind up with a large mortgage. If you are unable to pay at least 20% of the total price of the home as a down payment, you will likely have to obtain mortgage insurance. While this can add another layer to the home buying and refinancing process, navigating the waters of mortgage insurance does not have to be a complicated matter.
Learn more about what mortgage insurance is and the different options that are available.
Mortgage Insurance is a policy that protects the mortgage lender in cases where borrowers default on their payments, or are unable to meet their contractual obligations. Mortgage insurance is referred to as private mortgage insurance (PMI) and mortgage insurance premium (MIP), depending on the type of mortgage loan being insured.
Put simply, mortgage insurance is a type of policy that protects the lender in case you default on the loan in any way. The insurance is necessary for conventional purchase loans that have less than 20% of the purchase price as a down payment or have a loan-to-value (LTV) ratio of 80% or more when refinancing an existing mortgage loan into a conventional mortgage.
In many cases, when you hear the term mortgage insurance, it is in reference to private mortgage insurance (PMI). Private mortgage insurance only applies to conventional loans. VA loans and FHA loans each have their own types of insurance available and/or built into the program. PMI protects private lenders from default and allows buyers who may be unable to obtain a large down payment to purchase a home.
The cost of PMI for a homebuyer will vary from case to case. In many cases, it is typically around 0.25% to 2% of your loan balance per year. It will vary depending on your loan term, credit score and down payment.
If you have a $400,000 mortgage loan with PMI, then your annual mortgage insurance cost will be anywhere from $1,000 to $8,000 per year.
A buyer will only have to pay the PMI fee for as long as the equity of the home is less than 20%. You will have options to remove private insurance premium as you approach the 20% equity mark. You will either have to request the cancellation of this insurance I writing once certain criteria's are met, or your lender will cancel automatically. Either way, it is important to follow up with your lender and not assume it will occur automatically.
1. An upfront fee assessed at the time of closing.
2. An annual fee that you will pay in 12 monthly installments.
The rate of your MIP may vary depending on the length of the loan and the loan-to-value ratio (LTV). Unlike PMI, it can be harder to stop paying MIP. You may have to pay this fee for multiple years, if not for the life of the loan. Many borrowers have gotten around this difficulty and issue by simply refinancing their FHA loan into a non-FHA loan once they meet the terms of the agreement for the loan.
Now that you understand the basics of PMI and MIP, we will give you a couple examples:
An example of MIP paid annually would look the same as the PMI example above, except the cancelation requirements are much stricter. When the fee is calculated upfront and annually, it is quite simple. The rate is multiplied by the outstanding balance.
The number one way to avoid mortgage insurance is avoid attaining an FHA loan if possible, or to put down at least 20% of the purchase price when purchasing your home using a conventional loan, and making sure you have at least 20% equity available when refinancing your existing home loan into a conventional loan. If this is not possible, another option can include a piggyback loan (a separate loan used for a down payment).
Understanding the ins and outs of mortgage insurance is important if you are considering purchasing a home with less than a 20% down payment for a conventional purchase loan or refinancing an existing loan into a conventional loan when your loan-to-value ratio is more than 80%. Spend some time looking at the different options and make sure you choose something that will serve you well today and years down the line. If you are unclear of which options are best for you, take your time and talk with your real estate agent or loan officer about your concerns and future plans for the property before making a final decision.
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