If you’ve been reading up on home loans to get ready for your own home purchase, you’ve probably encountered lots of comments about avoiding mortgage insurance. With the press it gets, a fanciful soul might start to wonder if mortgage insurance was some kind of James Bond villain in the home loan world. What is mortgage insurance?
What Is Mortgage Insurance?
As Investopedia explains, mortgage insurance is an insurance policy that protects the lender or title holder if the borrower defaults on their loan payments or contractual obligations. Depending on the policy, the premiums can be due at closing, as part of your monthly mortgage payment, or at both times. In some cases, a single payment is all that’s necessary. Or, you may be able to stop paying once you achieve a certain amount of equity. Other loan programs require you to pay for mortgage insurance over the entire lifespan of the loan.
The Benefits of Mortgage Insurance
Mortgage insurance is an added expense for homebuyers, so it’s easy to understand why people are eager to avoid it. What is mortgage insurance good for? As NerdWallet points out, it does have its benefits. Mortgage insurance protects lenders in the event of a default. By doing so, it allows them to make loans available to borrowers who have smaller down payments or less-than-perfect credit.
Types of Mortgage Insurance
Mortgage insurance isn’t a must for every homebuyer. If you do require it, the type of mortgage insurance that you’ll need depends on the type of financing that you’re using. The Consumer Financial Protection Bureau offers a handy breakdown:
- Conventional Loan: If you make a down payment of less than 20 percent, you’ll likely need to pay for private mortgage insurance (PMI). PMI is paid monthly, and rates are based on your credit score and down payment. It’s cancelable once you have enough equity.
- Federal Housing Administration (FHA) Loan: With an FHA loan, you’ll be paying mortgage insurance premiums to the FHA. The FHA’s mortgage insurance is required on all FHA loans and has both a flat fee paid at closing and a monthly premium paid as part of your mortgage payment. The only way to end this form of mortgage insurance is to pay off your loan or refinance into another type of home loan.
- U.S. Department of Agriculture (USDA) Loan: Opting for a USDA loan means accepting a mortgage insurance program that operates much like the FHA’s program but is a little cheaper. Once again, you’ll pay a premium at closing and monthly premiums with your mortgage payments.
How to Avoid Paying Mortgage Insurance
Mortgage insurance can add hundreds of dollars to your costs, and if the policy does pay out, you won’t see a dime from it. When you consider those facts, it easy to understand why so many people are looking for ways to avoid paying mortgage insurance. Experian offers a few different strategies that you might find useful:
- Use a conventional loan with a 20-percent down payment. If you make a down payment of 20 percent or more, then you won’t be required to carry private mortgage insurance. What if you lack the funds for a down payment of that size? Gifts from family or friends can be used for a down payment as long as they’re properly documented. You may also be able to find down payment assistance programs*, especially if you’re a first-time homebuyer.
- Use a loan from the U.S. Department of Veterans Affairs (VA). VA loans don’t require mortgage insurance. If you’re eligible for one of these loans, you can get a home loan that provides 100-percent funding and favorable loan terms without any mortgage insurance.
- Use a piggyback loan. Piggyback loans are sometimes called 80-10-10 loans, and they’re designed to let you avoid mortgage insurance. With this arrangement, a homebuyer actually makes one down payment and takes out two loans. They make a down payment of 10 percent. Then, they take out a small loan equal to 10 percent of the down payment. That way, they’ll have a 20-percent down payment and be able to skip mortgage insurance.
*Certain restrictions apply. Not available in all areas. Please contact your PrimeLending loan officer for more details.