Buying a home usually has a monster obstacle: coming up with a sufficient down payment. You can put less than the traditional 20% down payment but the lender will likely require you to buy mortgage insurance.
The concept behind mortgage insurance differs from other insurance plans. You pay a monthly premium to the insurer who protects the mortgage lender in the event you default. There are two types of mortgage insurance: government and private.
What is PMI?
PMI is insurance for the mortgage lender’s benefit, not yours. It’s a concession often required when your down payment on the purchase of a home is less than 20%. Because the lender is assuming additional risk by accepting a lower amount of upfront money toward the purchase, it will often call for the borrower to purchase private mortgage insurance.
PMI is insurance for the mortgage lender’s benefit, not yours.
Private mortgage insurance will pay the lender a portion of the balance of the principal due if you stop making payments on your loan.
The cost of private mortgage insurance is based on the size and type of mortgage loan you apply for, and your down payment and credit score. The average annual cost can typically range from 0.41% to 2.25% of the original loan amount, according to insurance firm Genworth.
» MORE: Low down payment strategies
Can you ever stop paying PMI?
Once your mortgage principal balance is less than 80% of the original appraised value or the current market value of your home, whichever is less, you can generally cancel the private mortgage insurance. Often there are additional requirements, such as a history of timely payments and the absence of a second mortgage.
» MORE: How to get rid of PMI
Government mortgage insurance is different
Mortgage insurance for loans guaranteed by the Federal Housing Administration, U.S. Department of Agriculture and Department of Veterans Affairs operates a little differently from PMI for conventional mortgages.
FHA mortgage insurance
For 2018, mortgages backed by the FHA require a 1.75% upfront mortgage insurance payment as well as monthly mortgage insurance premiums ranging from .45% to 1.05%, depending on the loan term and amount.
» MORE: Is an FHA loan is right for you?
USDA mortgage insurance
Some USDA loans charge for mortgage insurance via two fees: an upfront guarantee fee you pay once and annual fee you pay every year for the life of the loan. The 2018 upfront guarantee fee is 1% and the annual fee is 0.35%. Both fees are evaluated each fiscal year.
» MORE: Is a USDA loan right for you?
VA mortgage insurance
VA loans to active, disabled or retired military service members and their eligible surviving spouses never require mortgage insurance, but most borrowers will pay a “funding fee” ranging between 1.25% and 3.3% for purchase loans. This fee depends on a wide variety of factors, including whether you’ve applied for a VA loan before and how much money you’re putting down, if any.
VA loans are also available to certain reservists and National Guard members. Others may also qualify. The VA Eligibility Center has details at 888-768-2132.
» MORE: Is a VA loan right for you?
How to avoid paying PMI
Mortgage insurance allows a lot of people to become homeowners who otherwise might not be able to. And it’s natural to want to put down as little money as possible, but you’ll want to consider the real costs, like paying for mortgage insurance.
The way the system works is: The larger the down payment, the better your financing deal. You’ll get a lower mortgage interest rate, pay fewer fees and gain equity in your home faster. And if your down payment is big enough, you’ll avoid PMI. But ultimately it’s a matter of balancing your short-term financial capabilities with the realities of your local real estate market, and your future savings and earnings potential to determine the best long-term financial result for you.