Coming up with the down payment is a common challenge for many prospective homebuyers. Many loan programs require minimum 20% down payments, so some borrowers find home ownership unaffordable.
Whether it's called “private mortgage insurance” (PMI) or just “mortgage insurance” (MI), mortgage insurance is a policy that protects the lender if you default on your loan. Don't confuse PMI with credit life insurance. Mortgage insurance won't pay your mortgage each month should you become disabled, unemployed, or deceased, and pays nothing to you or any of your beneficiaries.
PMI protects the lender on most nongovernment loan programs and, in most cases, a down payment of less than 20% requires PMI at an extra cost (monthly premium).
For loans directly backed by the government, such as FHA loans, all borrowers must pay into a self-insuring mortgage insurance pool to offset costs associated with other borrowers' defaults. While the FHA version is more like an annual-premium policy, paid at the time of closing, the up-front cost can be financed into the loan amount (which makes it tax-deductible).
For others government-backed loans, such as VA or USDA-backed loans, the government covers the risks of default, so MI policies are not required.
Mortgage insurance costs vary, depending on the down payment and the type of loan.
Lenders typically require mortgage insurance on loans in which the borrower makes an initial down payment of less than 20%. Simply put, MI allows a buyer to put less money down in exchange for a monthly premium. With FHA loans, borrowers can put down as little as 3.5% of a home's appraised value with the help of MI.
Mortgage insurance comes at a high price, however. A buyer who makes a 5% down payment and takes out a $200,000 mortgage could pay about $156 per month or $1,872 a year in MI.
Mortgage insurance typically can be cancelled once your loan is paid down to a certain percent of the value (LTV). Exceptions exist, however. The mortgage insurance on FHA loans with case numbers assigned after June 3, 2013 can last as long as you have the loan.
Two factors work in your favor when it comes to building enough equity to cancel your mortgage insurance:
- Amortization -- the process of paying off your mortgage
- Appreciation -- the increase in the value of your home over time
Before you commit to paying mortgage insurance, find out the requirements for cancellation from your lender. Your loan documents should include a PMI disclosure form that explains the details of the policy.
Refinance Your Way Out of MI
If you are considering refinancing, you should make sure the savings outweigh the costs. Remember, refinancing often comes with closing costs, appraisals, title searches, and underwriting fees.
If you have a current FHA loan, refinancing to remove your mortgage insurance could lower your monthly payment, even if the new loan's interest rate is a little higher.
Therefore, be certain the financial benefit is there before you proceed.
Get in touch with a PennyMac loan officer today and we will run the numbers to see if it makes sense for your financial circumstances.
- CFPB: When can I remove private mortgage insurance from my loan?
- HUD: Discontinuing Monthly Mortgage Insurance Premium Payments