Understanding Mortgage Insurance
Mortgage insurance allows future homeowners to put less money down when they can’t quite afford a 20% down payment. For most people, that means becoming a homeowner when they wouldn’t have otherwise been able to do so. We think that’s a pretty good thing!
Have you heard of Mortgage insurance, but don’t know what it is? Is it necessary or unnecessary? You’re probably thinking, “Mortgage insurance sounds like another additional monthly charge I have to pay.” Simply put, Mortgage insurance allows future homeowners to put less money down when they can’t quite afford a 20% down payment. For most people, that means becoming a homeowner when they wouldn’t have otherwise been able to do so. We think that’s a pretty good thing!
Mortgage insurance is different from your Homeowners insurance. Homeowners insurance covers your house in case of an emergency, and your mortgage insurance is in place to protect the lender who is lending you money to purchase your home. Mortgage insurance does not cover you personally, it is simply a protective measure for the bank in case you stop making payments, or foreclose on your home. If you foreclose with Mortgage insurance the bank still is protected and receives payment.
Typically, homebuyers who put less money down are at higher risk to default on their mortgage. To feel comfortable lending money, the lender takes out an insurance policy that you pay for. Not all mortgages have mortgage insurance, and you may wonder, “When is it necessary to have mortgage insurance?” Lenders see homebuyers as a lending risk if they put less than 20% down payment or have less than 20% equity on a refinance, and they will require a Mortgage insurance policy to be in place. On the contrary, if you have 20% down or 20% equity, you don’t need to have Mortgage insurance on your transaction. If you do not have a Mortgage insurance policy, it makes your monthly payment more affordable.
A mortgage insurance premium may be paid upfront on the loan or monthly. In some cases, you may have to do both. With an FHA loan, homebuyers pay insurance upfront and monthly. The monthly insurance will be present for the life of the loan unless you put at least 10% down. In this instance, it will drop off after a set amount of time, usually around eleven years. If a homebuyer put less than 10% down, they’re attached to paying the mortgage insurance until the sale of the house or refinance from that FHA loan. With a conventional loan, future homeowners do not have the upfront mortgage insurance payment but, still have the private mortgage insurance payment (PMI) vs monthly mortgage insurance (MMI) on an FHA loan. Private Mortgage insurance serves the same purpose as monthly Mortgage insurance on an FHA loan, and that is to protect the lender if you stop making your payments and foreclose on the house. There are two determinations to make when considering the differences between PMI and MMI. The biggest difference between the two is if and when the insurance will drop off of your loan, With PMI, once you reach 78% loan to value, it will automatically drop off, or once you get to 80% loan to value (you have 20% equity in your house) you can call and request that the PMI come off of your loan.
There are some benefits to having these insurances on your loan. For instance, depending on the loan type, you have to put down as little as 3% which means that you can keep more money in the bank. Maybe you’re sick and tired of throwing your money away on rent and want to purchase a house now but can only afford to put 3% or 4% or 5% down. You can take that next step into home ownership, but the tradeoff is you will have to pay mortgage insurance. The lender is going to look at someone who’s putting less down as a higher risk vs someone who is putting more down on the house.
Maybe you’re wondering, will Mortgage insurance make my loan interest rate lower? Oftentimes, when you put less than 20% down and the bank options for your loan to include mortgage insurance, they may be able to give you a little better interest rate! There is no risk to the bank if you stop paying your loan because the loan is covered by Mortgage insurance. If you are unable to make payments, the bank will pay off the loan. This will still result in a derogatory mark on your credit, but at least there is no risk to the bank.
Understanding how mortgage insurance works and how it applies to you as a home buyer will help save you money in the long run. Here are 3 tips when considering Mortgage Insurance.
1. Choose a term length that matches the length of time you plan to pay off your mortgage. Also, consider the amount of time that you will have dependents who rely on you for housing, financial support, etc.
2. Consider adding policy riders. Mortgage insurance is an affordable life insurance option. It is also very adaptable and can be customized to fit your needs.
3. Find the right price. Mortgage insurance is budget-friendly and competitive, a licensed agent can shop the top carriers to find the lowest rate.
There are pros and cons to Mortgage Insurance. Talk to a lender and weigh your options to see what works best for you!