Some people have lots of money for a down payment. For everyone else, there’s mortgage insurance. If you have already determined that you can’t afford a standard down payment on a home (usually 20% for conventional loans) but you still want to buy, don’t despair. Mortgage insurance exists to help make you a more attractive candidate to lenders.
What is mortgage insurance?
Here’s the deal: you want to borrow lots of money but you don’t have much saved up, so the bank isn’t sure it can trust you. How do you prove that giving you a mortgage isn’t too risky? By buying mortgage insurance.
With private mortgage insurance, you pay additional money each month to give the bank the peace of mind that comes with knowing they’ll be covered by the insurance policy if it turns out you can’t make your mortgage payments. Unlike with most other forms of insurance, with mortgage insurance you pay the premiums but you’re not the beneficiary — the bank is.
Do conventional loans require mortgage insurance?
If you’re getting a conventional mortgage and your down payment isn’t up to the 20% mark, you’ll need to pay for a private mortgage insurance (PMI) policy. Private mortgage insurance premium rates vary based on the loan-to-value ratio on the home, your credit score and whether your mortgage is fixed-rate or variable-rate. (The better your credit, the lower your PMI payments will be — yet another reason to check, build and maintain your credit.) The loan-to-value ratio is the amount of money you’ve borrowed for the home compared to the value of the home. The more money you use as a down payment, the less you have to borrow and the more favorable this ratio is in the eyes of the lender.
Because PMI is tied to the loan-to-value ratio on your home, the amount of PMI you pay each month will decline over time as you build equity. (Building equity means you are paying off some of what you borrowed so you own a larger percentage of the house.) Don’t think you’re locked in to paying PMI for the life of the mortgage, either.
Thanks to the Homeowners Protection Act of 1998, when your loan is scheduled to reach 78% of the home value or sales price (whichever is less) the bank has to cancel your PMI. If you’ve paid on time and you think your home’s value has changed since the time of purchase, you may even be able to negotiate an earlier cancellation of your PMI. If you discover that your PMI wasn’t canceled when it should have been you may be eligible for a mortgage insurance premium refund.
Here’s another tip: Don’t count on your lender to tell you when your PMI is eligible for cancellation. As you can imagine, banks often drag their heels at this stage, hoping to get more payments out of borrowers who haven’t realized they’ve hit the 22% equity mark. The solution? Be pro-active. Keep track of how your payments are eating away at your loan and contact the bank to let them know that your PMI cancellation date is coming up.
What if I have an FHA loan, not a conventional loan?
Why didn’t you say so? Mortgage insurance for loans backed by the Federal Housing Administration works a little differently. With most FHA loans, you’ll need to pay for both the up-front mortgage insurance premium (UFMIP) and the annual mortgage insurance premium (MIP). The UFMIP is calculated as a percentage of your loan amount, regardless of the term of the loan or the loan-to-value ratio (LTV).
The annual MIP, on the other hand, takes into account both the loan term and the LTV. It’s expressed in basis points, with one basis point equal to 1/100th of 1%. Your annual MIP, broken down by month, will get added to your regular mortgage payments.
Although FHA gets government funds to run its programs, the money you pay in mortgage insurance helps keep it afloat. That makes FHA insurance fees similar to the funding fees for VA loans.
VA loans have fees?
Yup. VA-backed loans, like FHA loans, require some money from borrowers on top of what taxpayer money provides. While VA loans don’t require mortgage insurance, they do require a one-time funding fee that’s similar to the FHA loan’s UFMIP.
How can I get out of paying mortgage insurance?
If you don’t want to pay mortgage insurance, try to bump your down payment up to the 20% mark. You can wait longer to buy, ask for help from friends or family, etc. A lot of people don’t factor in the cost of mortgage insurance when planning their housing budget.
Could you afford to put a little more down now to avoid paying mortgage insurance later? If so, go for it! Our mortgage calculator will help you calculate what your mortgage insurance premium would be based on different down payment amounts.
While a 20% down payment is the best way to avoid paying PMI, there is another way. This involves taking out two loans at the same time. Often called a piggyback, 80/10/10 or 80/15/5 loan, it essentially fills in the gap between how much money you have available for a down payment and that magic 20% of the home value.
In this scenario, you put down 10%, take out a mortgage for 80% and a piggyback loan for 10%. This loan will usually come with a higher interest rate. Whether a piggyback loan makes sense will depend on just how high that interest rate is, but a piggyback loan does mean you avoid paying PMI.
Is there a mortgage insurance premium deduction?
Not anymore. Between 2008 and 2013 Congress allowed buyers to write off their PMI mortgage premium payments but that deduction ended. That’s another reason to save up for a bigger down payment and avoid PMI if you can.
What happens to my PMI if I refinance?
Great question! Remember that to avoid PMI your loan-to-value ratio must be 80% or less. If your home has appreciated since you bought it, you may be closer to the 80% ratio than you think. You can also make improvements to the home to increase its value and by extension lower your loan-to-value ratio. The basic principle is this: if you owe the same amount as you did before the re-appraisal but your home is suddenly worth more, your loan-to-value ratio has gone down.
If the value of your home has gone up, refinancing to get rid of PMI might be the right move, but you’ll need to consider the cost of the refinance itself. That’s because refinancing comes with the expense of a new appraisal and a new set of closing costs.
We hope it goes without saying, but we’ll say it anyway: before you commit to a costly refinance, check your home equity and see if you’re already eligible for PMI cancellation. And remember, you can also refinance from an FHA loan to a conventional mortgage if you want to avoid MIPs.
No one actually likes paying for mortgage insurance but for many people it’s the only way to secure a mortgage and get on the property ladder. If you’re in an area where it’s much cheaper to buy than rent, financing a home purchase — even if you’ll need PMI — can save you money in the long term.