Mortgage Insurance - What is PMI and how does it work?
Mortgage Insurance: 7 Things Consumers Need to Know
Mortgage lenders make many borrowers purchase mortgage insurance to protect the lender if the borrower is unable to pay the mortgage. In other words, mortgage insurance guarantees your lender will get paid if you default. For the borrower, it has a benefit, too: Getting mortgage insurance allows you to purchase a home before you have the full 20 percent down payment saved up.
Here's a primer on what you need to know about mortgage insurance:
1. What are the different types of mortgage insurance?
In general, there are two types of mortgage insurance: mortgage insurance bought from the government, designed for those with FHA or VA loans or mortgage insurance for conventional loans which is bought from the private sector (this is called private mortgage insurance or PMI), Basically, the type of mortgage insurance required will depend on the type of mortgage loan you get.
2. Who is required to have mortgage insurance?
Typically on a conventional loan, if your down payment is less than 20 percent of the value of the home, lenders will require you to carry mortgage insurance. Usually, you pay those mortgage insurance premiums until your loan-to-value ratio (LTV) -- this is simply the amount of money you borrowed divided by the value of the property you bought -- hits 80 percent. For example, let's say you bought a $100,000 home and put down 10 percent, or $10,000, and got a $90,000 loan to pay the rest. Your LTV in this case would be $90,000 divided by $100,000, or 90 percent. The longer you pay down your mortgage, the lower your LTV will become. On government loans, mortgage insurance is normally required regardless of the LTV.
3. What does mortgage insurance cost?
Conventional Mortgage insurance rates vary -- usually, the lower your down payment and/or the lower your credit score, the higher the premiums -- but typically the premiums can range from $30-70 per month for every $100,000 borrowed. So, if you bought a $300,000 home, you might pay about $150 per month for mortgage insurance. On FHA loans, there is an up-front MIP (mortgage insurance premium) and annual premium which is collected monthly. VA loans have an up-front fee(funding fee) and no annual or monthly premiums. Contact your lender for specific details.
4. What does mortgage insurance cost?
Typically, you'll pay your mortgage insurance premiums monthly right along with your mortgage payment (you can just send one payment to the lender). Lenders may also allow you to pay your PMI on a lump sum basis either in cash at closing or finance the premium in your loan amount.
5. Why do I need mortgage insurance?
Your lender requires you to have mortgage insurance so that if you can no longer make payments on your home, the lender will still get paid (through the insurance policy). Mortgage insurance basically safeguards the lender in the event of borrower default.
6. How can I avoid paying mortgage insurance premiums?
If you put down 20 percent or more when you buy a home, you can typically avoid paying mortgage insurance on a conventional loan. And once you've built up a certain amount of equity in your home, you can request to cancel it (see below).
7.When does mortgage insurance “fall off” the loan?
Once the borrower has built up a certain amount of equity in the house, typically 20 percent, the mortgage insurance policy usually may be canceled. The lender usually won't automatically cancel PMI until you've reached 22 percent equity based on the original appraised value of the home, but you can request cancellation at 20 percent of the current market value. So if you own a home worth $100,000 and have paid down $20,000 in principal, you can request to cancel your PMI.