If you?re like many borrowers who have less than 20 percent of a home?s value in equity or saved for a down payment, you need to know how mortgage insurance affects the cost of buying a home.
WHAT IS MORTGAGE INSURANCE?
Mortgage insurance ? also known as private mortgage insurance, or PMI ? protects lenders from default on conventional mortgages in cases in which the borrower contributes a down payment of less than 20 percent of the home?s purchase price. PMI is different from homeowners insurance, which protects the home and what?s in it. It?s also different from mortgage protection insurance or mortgage life insurance, which is an insurance policy that pays off the mortgage loan if the borrower passes away.
Mortgage insurance is beneficial to both lenders and borrowers. Mortgage insurance lowers a lender?s risk of giving a loan to borrowers with a low down payment. It also benefits the borrower, who, with mortgage insurance, might now qualify for a mortgage he wouldn?t otherwise get approved for.
WHAT YOU?LL PAY FOR MORTGAGE INSURANCE
The cost of mortgage insurance depends on the type of home loan you have. You could pay anywhere from 0.3 percent to 1.15 percent of your home loan, according to Realtor.com.
Although insurance premium payments usually get paid monthly, you might have the option to pay it up front at closing or roll it into the home loan cost. Check with your lender.
MORTGAGE INSURANCE FOR DIFFERENT TYPES OF HOME LOANS
Mortgage insurance programs vary depending on the type of home loan. Generally, mortgage insurance is required when you get a conventional mortgage and put down less than 20 percent or when you refinance a mortgage and your home equity is less than 20 percent.
Other types of mortgage insurance include:
?Federal Housing Administration mortgage insurance (mortgage insurance premium): An MIP is required for all FHA loans. All borrowers pay their mortgage premiums directly to the FHA, and premiums are the same for everyone regardless of credit score ? though if your down payment is less than 5 percent, you can expect to pay a little more. If you get an FHA loan, budget for both monthly MIP costs as part of your regular payment and an upfront payment included in your closing costs. FHA mortgage insurance rates are usually about 0.625 percent.
?U.S. Department of Agriculture home loan insurance: U.S. Department of Agriculture insurance covers USDA home loans. It?s a lot like FHA mortgage insurance but less expensive. USDA home loan insurance requires making a payment both at closing and as part of your monthly payments. You have the option to roll the upfront cost into your mortgage, but if you do this, you?ll increase both your monthly payment and your overall loan cost.
?VA home loan guarantee: VA loans come with a mortgage guarantee instead of mortgage insurance, but it provides similar benefits. Instead of a monthly mortgage insurance premium, you?ll pay a funding fee upfront. The fee amount varies depending on factors like your military service type, down payment amount, disability eligibility, whether you are purchasing or refinancing, and if you?ve had a previous VA loan.
ALTERNATIVES TO MORTGAGE INSURANCE
Although there are benefits to mortgage insurance, having it adds to the cost of getting a home loan. If you want to cut costs or are ready to get rid of PMI, consider these five alternatives to mortgage insurance.
?Pay a higher interest rate
When financing a home, some lenders might offer the option to avoid PMI by accepting a higher interest rate. If you choose this option, the higher mortgage rate cannot get canceled, so you?ll have to refinance to lower your rate in the future.
?Get your home reappraised
If you believe you now have at least 20 percent equity in your home due to renovations or the rising local property values, get your home reappraised. You might have enough equity to cancel your mortgage insurance, but you?ll have to pay for the appraisal upfront.
?Get a piggyback loan
Whether your lender calls them piggyback loans or piggyback mortgages, these home equity loans or credit lines enable borrowers with low down payments to borrow more money. Before applying or signing for one, review the fine print carefully to see if your total monthly cost is actually cheaper than paying for mortgage insurance.
?Ask your lender about other programs
Some lenders offer programs that don?t require mortgage insurance, even with down payments below 20 percent, though you?ll likely have to prove that you have excellent credit to qualify. Before talking to your lender, focus on building your credit history, especially if you or your spouse has bad credit.
?Save more for a down payment
Sometimes it pays to wait and save up or to choose a home that requires a down payment you can afford. If you save 20 percent of the home?s purchase price to use as a down payment, you might qualify for a conventional mortgage without mortgage insurance. A conventional loan comes with a lower interest rate, and you?ll be able to avoid the headache of comparing mortgage insurance rates altogether.