Purchasing a home is still the American Dream for many. But with rising house prices and increasing expenses, that dream may seem out of reach. A common misconception is that you need to save 20 percent of the price of a house to purchase it, but mortgage insurance changes all that.
TL;DR (Too Long; Didn't Read)
Mortgage insurance allows you to purchase a home using a lower down payment. When you take out a loan with mortgage insurance, you can make a down payment of less than 20 percent of the house’s value.
What Is Mortgage Insurance and What Does it Cover?
Mortgage insurance was created to protect the lender in case a homeowner defaults on her mortgage payments. Lowering the lender's risk helps you qualify for a home loan you may not otherwise get. Mortgage insurance does not cover anything for the borrower.
If you can take out a traditional home loan but cannot make a large down payment, you may be able to get private mortgage insurance (PMI). PMI works the same way as mortgage insurance, with better rates available to those with good credit.
You must pay mortgage insurance for loans through the Federal Housing Administration (FHA) and the U.S. Department of Agriculture (USDA). These lenders allow low down payments.
FHA provides loans to borrowers with good credit who can make a down payment of 3.5 percent to 15 percent. USDA provides loans to low- and moderate-income borrowers in rural areas. With a USDA loan, a down payment may not even be needed.
How Much Is Mortgage Insurance for an FHA Loan?
There are two costs associated with all mortgage insurance, including mortgage insurance for an FHA loan: the one-time premium and the annual mortgage insurance premium.
The one-time premium is paid upfront as part of your escrow closing costs. This amount is typically less than 2 percent of your loan. For example, if you borrow $500,000, your upfront premium may be up to $10,000. If this is too much for you to pay out of pocket, you can roll it into the cost of your mortgage. This will increase your loan amount and the overall cost of your loan.
The annual mortgage insurance premium depends on the cost of the house, the amount of your down payment, the insurer and your credit score. It also depends on how much you owe on your mortgage compared to the value of the property (the loan-to-value ratio).
For example, if you make a down payment of $40,000 and your house is valued at $600,000, you have a mortgage of $560,000. Your loan-to-value ratio is determined by dividing your loan amount ($560,000) by the home’s value ($600,000), then multiplying the result by 100. In this case, your loan-to-value ratio is 93 percent.
To determine your monthly mortgage insurance payment, you’ll have to look at your lender’s payment chart. Once you know the rate required by the chart, multiply your loan by the rate to determine your annual payment. For example, if the chart shows a rate of 0.0080 percent, you would owe $4,480 a year in mortgage insurance. That works out to about $370 per month on top of your monthly mortgage payment.
Mortgage insurance is generally a monthly payment of between $30 and $70 for every $100,000 borrowed. For example, if you take out a loan of $500,000, your monthly mortgage insurance premium would be between $150 and $350 in addition to your monthly mortgage payment.
How Long do You Have to Pay Mortgage Insurance?
PMI must be paid until you have more than 20 percent equity in your house. When that happens, PMI automatically terminates. This may take several years, so be sure you are aware of your repayment timeline and charges.
If you take out an FHA or USDA loan, you are required to pay mortgage insurance premiums for the life of the loan. These loans cannot be cancelled. The only way to get rid of mortgage insurance from an FHA or USDA loan is to refinance your house with a conventional loan once you have built up some equity in it.
What Does Mortgage Insurance Cost?
Work with your lender to determine how much your monthly mortgage insurance would be based on different variables. You can also use an online calculator to quickly run different scenarios.
Keep in mind that mortgage insurance does not protect you from losing your home. You still have to make your monthly mortgage payments as well as your monthly insurance payments, or you risk foreclosure.
- Consumer Financial Protection Bureau: What is Mortgage Insurance and How Does it Work?
- Consumer Financial Protection Bureau: When Can I Remove Private Mortgage Insurance (PMI) From my Loan?
- Consumer Financial Protection Bureau: Special Loan Programs
- My Home by Freddie Mac: Paying PMI, Property Taxes & Homeowners Insurance