There were 1.8 million first time home buyers in 2016. Buying a home is full of unusual terms and stress-inducing paperwork. So much paperwork.
It comes with a lot of questions too. What’s the difference between the fixed interest rate and variable? Is a 15-year mortgage better? What is mortgage insurance? Do I need it?
There’s a lot of questions there, so we’ll tackle them one at a time. First, let’s talk about mortgage insurance.
What is Mortgage Insurance?
Let’s look at it this way. When you get health insurance, you’re paying to insure your health. That means if something goes wrong with your health, your insurance company will pay to fix it.
When you get car insurance, you’re paying to insure your car. That means if you get into a car wreck, your insurance company will pay to fix it.
So when you get mortgage insurance, you’re paying to insure your mortgage. That means if you fail to pay your mortgage, your insurance company will repay your lender.
That’s a good thing right? Er, no not exactly. You still lose your house since you can’t afford it. It goes into foreclosure. On top of that, your credit score takes a huge hit.
No matter what, mortgage insurance protects your lender, not you. Since you’re not protected, why do you have to pay the insurance? Because the bank has the money and you need it.
So why on earth would you ever get mortgage insurance? Don’t worry, we’ll explain that too.
Where does it come from?
The type of loan you get will, in part, decide where you get your mortgage insurance. You can get it from a private insurance company. But often, your lender will pick it for you.
With a conventional loan, they’ll usually pick a private mortgage insurance (PMI) company. PMI rates are generally cheaper than the Federal Housing Administration (FHA) rates.
This kind of mortgage insurance is generally paid monthly. In some cases, you can even cancel it.
Federal Housing Administration Loan (FHA)
If you get a home through the FHA, the mortgage insurance is paid to the FHA as well.
Plus it comes with upfront costs, usually covered when you close your house. Your insurance payments are typically monthly and tied to your mortgage payments.
US Department of Agriculture Loan (USDA)
USDA loans follow the same general rules as FHA loans. But they’re cheaper!
USDA loans have a handful of qualifications. The property you’re buying has to be located in an eligible rural area. And it has to be your primary residence – not a vacation home.
But hey, if small town life is your kind of thing, maybe look into getting a USDA loan.
Department of Veteran Affairs (VA-Backed Loans)
If you get a VA loan, you don’t need mortgage insurance. But there is a funding fee that will vary.
How Much Does it Cost?
The cost of your mortgage insurance will vary.
Factors include the size of the mortgage, your down payment, your credit score. Your debt-to-income-ratio will also play a part. So will the company you use for your mortgage insurance.
You can find a calculator here.
So how about a debt-free couple with an excellent credit score buying a $150,000 starter home with 3% down? They’ll likely pay about $35 a month.
Why is it Useful?
Since mortgage insurance protects the lender and not you, why even get it? Most likely, you have to.
If you have less than 20% for a down payment, your lender will likely require mortgage insurance.
It’s the same sort of thing where the apartment company makes you get renters insurance. They’re just trying to protect their investments.
Most lenders will give you a mortgage with at least 3% down. That’s savings of only about $5,000.
A $30,000 20% down payment on a $150,000 house seems unattainable. But $4,500 can get you into your own home. Mortgage insurance and 3% down might be all it takes for you to become a homeowner.
How Can I Avoid It?
So what if you’re adamant about not paying for things that you don’t use? Really, no one can blame you. How do you avoid mortgage insurance?
There are two (technically three) ways.
The first is a silent loan that you get from some other entity. It’s silent because you don’t tell your mortgage lender about it. And that’s super illegal, so don’t do it.
The second is with a piggyback loan. Piggyback loans are usually only good for up to 10% of the home’s cost. They’re a second mortgage that’s backed against the house’s equity. It covers your remaining 20% down payment.
They also come at a higher interest rate than your primary mortgage. The interest may be higher than mortgage insurance. So factor that in if you’re considering a piggyback loan.
The third way is to just save up 20% for a down payment. Most lenders don’t require mortgage insurance if you have 20% down.
Mortgage Insurance: Do I Need It?
We finally answer the question. Do I need it? If you can afford a 20% down payment on your new home, then no. You don’t need mortgage insurance.
But if you’re trying to buy your first home and you don’t have a full 20% to put down then yes, you need it.
Mortgage insurance gets a bad rap. But it doesn’t have to. It may be the exact tool you need to become a homeowner.
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