Whether you are just starting your home buying journey or well on your way, a phrase you need to know about is Mortgage Insurance…
I am sure you could do some quick searches and find out the various definitions. Such as how Wikipedia defines mortgage insurance:
…an insurance policy which compensates lenders or investors for losses due to the default of a mortgage loan. Mortgage insurance can be either public or private depending upon the insurer.
Also Freddie Mac defines mortgage insurance this way:
An insurance policy that protects the lender if you are unable to pay your mortgage. It’s a monthly fee, rolled into your mortgage payment, that is required for all conforming, conventional loans that have down payments less than 20%.
Once you’ve built equity of 20% in your home, you can cancel your PMI and remove that expense from your mortgage payment.
So this means that unlike home owners insurance which covers your butt if something happens to the property, mortgage insurance is meant to protect the lender.
When you have a mortgage, you will be paying monthly premiums for the mortgage insurance BUT the mortgage lender is the beneficiary. Freddie Mac explains this:
The cost of PMI varies based on your loan-to-value ratio – the amount you owe on your mortgage compared to its value – and credit score, but you can expect to pay between $30 and $70 per month for every $100,000 borrowed.
I know this does not sound right but it is one of the mandatory things that lenders will require IF you put down less than 20%.
No Matter What You Call It
I usually hear it called Private Mortgage Insurance or PMI. Maybe you are used to hearing it shortened to mortgage insurance or you may be used to hearing Lenders Mortgage Insurance. It doesn’t matter what you call it because unless you are putting more than 20% down when you get a mortgage, you will be paying for it!
According to NAR, home buyers used an average down payment of 10% in 2017.But if we look at first-time home buyers, the average down payment decreased to 5%!
Let’s look at the difference between the monthly payment on a $200,000 home with a 5% down payment & PMI and a 20% down payment without PMI:
The more you put down, the lower your monthly housing payment will be. While putting down as much as you can will lower your monthly payment, it may not be the bes t choice!
Freddie Mac says:
It’s no doubt an added cost, but it’s enabling you to buy now and begin building equity versus waiting 5 to 10 years to build enough savings for a 20% down payment.
This is very true with if home prices and/or mortgage rates are increasing.
Sounds Bass Ackwards…
I know it sounds strange that you are paying insurance for someone else’s benefit. Unlike other types of insurance which you pay to protect your interests, you pay PMI to protect the lender’s interests. You need to understand that mortgage insurance is required by lenders to protect them.
If you don’t want to pay for it then you can put more than 20% down…
The good thing about mortgage insurance is that it gives the lender a warm fuzzy feeling about giving you a mortgage. So even if you are making a super low down payment, the lender feels their investment is protected. Which makes it easier for you to get approved for the mortgage!
This Too Shall Pass
More good news is that you are NOT stuck paying mortgage insurance forever. Once you have paid down your mortgage to a certain point, you can request cancellation of the mortgage insurance.
So how much are we talking about?
80% of the original purchase price or appraised value, whichever is less
The Homeowners Protection Act requires that mortgages made after 1999 notify you when you get to this point. Not only that, but your mortgage insurance payments must be automatically canceled once you pay down your loan to 78%!
At closing, and on a yearly basis, you should receive information from your lender about when you can request cancellation. However, I would not rely upon the bank to let you know about this. Instead, you need to somehow remember when you will get to this point.
Unless you like paying extra. I am sure the bank won’t complain…
Now here is the kicker. Take the money you have been paying for mortgage insurance and instead of blowing it, start adding it to your monthly mortgage payment. This is a great way to help you to pay off your mortgage just a little quicker.
Or use it to pay off another debt that is at a higher interest rate.
Just don’t blow it!
Also, you need to understand that mortgage insurance does NOT mean you don’t also need home owner’s insurance! Besides, lenders are going to require that you pay for home owner’s insurance also. Not that having home owner’s insurance is a bad thing.
As always, I am providing this to you for informational purposes only! I am not a mortgage lender and you should contact the lender of your choice directly to learn more about its mortgage products and your eligibility for such products.