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If you've been thinking about buying a home or have friends who have purchased their own homes, you may have heard the term mortgage insurance or PMI before. What is mortgage insurance? We'll use the rest of the article to dig into that.
What is Mortgage Insurance?
Before we talk about mortgage insurance specifically, let's talk about why any kind of insurance is out there.
Insurance is a financial product that helps a party avoid a huge financial loss. The reason you pay car insurance is to protect yourself from losing everything due to a bad car accident. The insurance company will cover most of the costs, which can add up quickly if it's a multi-car accident and people get injured.
Mortgage insurance also exists to help prevent a huge financial loss. The difference is that it isn't protecting you, the homebuyer, from anything. It's protecting the lender from losing a lot of money on the loan.
The monthly premium is essentially a way for the lender to lower its risk of losing money on the loan. Mortgage insurance annual costs are typically between 0.5% – 2% of the loan value, so it comes out to between $1,000 to $4,000 on a $200,000 mortgage.
Who Needs to Pay Mortgage Insurance?
If you buy a home and get a conventional loan, the lender's preference is to get a downpayment of at least 20%. If you have the cash to do that, you don't need to pay mortgage insurance.
If you don't have enough cash, you'll need to pay mortgage insurance. This won't come as a surprise, as your lender will tell you multiple times, it will be included in your paperwork, etc. For a conventional loan, mortgage insurance is called private mortgage insurance, or PMI.
FHA loans are a bit different. No matter how much money you put down on the home, you'll need to pay mortgage insurance.
VA loans are also different. There is never a mortgage insurance requirement, regardless of how much money you had available to put down on the home.
How Do You Get Rid of Mortgage Insurance?
If you have a conventional mortgage, there are two ways to get rid of PMI.
- Pay off enough of the loan that you reach at least 22% equity in the home
- Refinance, again so you have enough equity in the home
The best route for you is dependent on a lot of factors, either one can make sense depending on the current interest rates, your season of life, etc.
If you have an FHA loan, you can't get out of paying mortgage insurance as long as the loan is active. Even if you live in the home for 20 years and get a lot of equity, mortgage insurance will still be due every single month.
That's why a lot of people who initially buy a home with an FHA loan will refinance into a conventional loan as soon as they can. That way they can eventually be rid of PMI.
Mortgage insurance isn't fun to pay but at least it lets you finally be able to buy your own home! It's better than the alternative, which is continuing to pay someone else's mortgage each month when you rent. Give us a call at (877) 306-0222 and we'll bend over backward to help you buy your own home.