Did you know you can purchase a house even if you haven’t saved up a 20% down payment? It’s true. Though, you will be expected to pay private mortgage insurance or a mortgage insurance premium, which will be dependent on the loan program you choose for home financing.
PMI vs. MIP
Let’s take a look at mortgage insurance options. PMI stands for private mortgage insurance, and MIP stands for mortgage insurance premium. While they may sound similar, there is a significant difference between the two. PMI goes hand in hand with conventional loans, and it can eventually be dropped. MIP is tied to government-backed programs, like the FHA loan. It’s something you are required to pay for throughout your mortgage (unless you refinance to another loan program).
Learn the difference between FHA and conventional loan programs thanks to help from our friends at American Financing.
For the sake of this article, we’ll focus on private mortgage insurance. Here’s everything you need to know.
Purpose of private mortgage insurance
Most consumers who purchase insurance receive some sort of protection or coverage. Think healthcare, dental, or homeowners insurance. So how can your mortgage insurance protect you? Well, to be honest, it doesn’t. Instead, its purpose is to protect the lender in the event you default on your loan; because the less money you put down, the riskier you are to a lender.
But don’t be discouraged; there is a great benefit to you, as the borrower. And that is the ability to get into your own home for less than 20% down. You see, waiting for another three to five years to save up an extra $15,000 dollars or so can get expensive. Think potential rent increases or your dream home’s sales price going up. Let’s not forget that dream home would likely be off the market by the time you saved that 20%. Of course, everyone’s situation varies, but private mortgage insurance isn’t something you should immediately write off. It does have it’s benefits.
Mortgage insurance calculator
To illustrate potential benefits, let’s take a look at how private mortgage insurance is calculated. After all, seeing the costs and potential long-term savings may help you in the decision-making process.
First, it’s important to know that the actual cost may vary based on your mortgage insurance company. You are, unfortunately, not able to shop for companies or negotiate premiums. So, we’ll keep it simple by using a mortgage insurance calculator that can provide a general idea of PMI payment required in addition to your principal and interest.
Say the house you are buying is listed for $400,000. You can put $15,000 down, and you’re pre-approved for a 30-year fixed-rate mortgage. You’ll likely be expected to pay about $144.38 a month in PMI. Again, that does not include your principal, interest, taxes, and insurance, or PITI.
While that may sound like a lot, you need to consider the alternative. If that house truly is your dream home and you have a desire to buy it without paying PMI, you’ll need to come up with $80,000 for a down payment (which is 20% of the purchase price). So you’ll need to ask yourself, which approach is right for your financial situation?
How to avoid PMI
If you’re not sold on the opportunities that private mortgage insurance can offer you, and you still think it’s just not worth it, there are ways to avoid PMI.
- Make a larger down payment — this can include using gift money from parents or relatives (though rules and restrictions may apply)
- Look into a VA loan if you or your spouse is a veteran or on active duty — there’s no down payment and no mortgage insurance required
- See if you can pay a higher interest rate
- Consider a combination loan like an 80/10/10 mortgage where you finance 80% via a first mortgage, make a 10% down payment, and obtain a 10% second mortgage
Remember, unlike MIP, PMI isn’t forever. Once your loan balance has reached the 80/20 loan-to-value (LTV mark), it is possible to cancel private mortgage insurance. You’ll need to contact your mortgage servicer and ask them to remove it. Know that they may require an appraisal to verify your home’s LTV.
If you forget about it or just aren’t paying close attention, that’s fine. Once your LTV drops to 78%, your lender is required to remove PMI, as stated in the Homeowners Protection Act (or PMI Cancellation Act).
Want to learn more about the pros and cons of private mortgage insurance? Let one of our real estate experts help. Give us a call at (303) 695-5900.