I Need Mortgage Insurance, Too?
If you’ve spent any time researching the costs associated with homeownership, then you’re probably already familiar with private mortgage insurance, also known as PMI. Still, it’s a good idea to know exactly what you’re getting yourself into. With that in mind, we’ll discuss the finer points of the mortgage insurance concept.
Mortgage Insurance Protects the Lender
Normally, when you purchase an insurance policy, it’s designed to protect you. But that’s not how mortgage insurance works; its purpose is to protect your lender. When a bank or other lender grants a mortgage, that entity is taking a risk. After all, there’s always a chance that the borrower will become insolvent or otherwise unable or unwilling to make their mortgage payments. Foreclosures are costly for banks. Remember – Banks are not in the property management business. When they foreclose on a mortgage, they become property owners, and they have to pay for upkeep and maintenance, among other things. In order to recoup their losses and to limit their liability, they may end up having to sell a foreclosed home for less than they lent the borrower. Mortgage insurance insulates lenders against potential losses from defaulted mortgage loans.
Who Needs Mortgage Insurance?
Some homebuyers are required to pay for mortgage insurance while others are able to sidestep the requirement. Why is that?Well, mortgage insurance is required of purchasers who have less than the traditional 20% down payment. Twenty percent was once considered to be the standard down payment needed to purchase a home, but these days that’s no longer the case. Many homebuyers are qualifying for a mortgage with as little as 3% down. That being said, 20% is still the magic number for lenders. Mortgage borrowers with “skin in the game” are less likely to default on their mortgage payments, so they’re a lower-risk investment for mortgage originators, which is why conventional borrowers with less than 20% are required to pay for mortgage insurance.
When Can You Stop Paying for Mortgage Insurance?
The good news for borrowers is that once they’ve built at least 20% equity (or during the first 5 years of the mortgage, 25%), they’re no longer required to pay for mortgage insurance. For those who reside in rapidly appreciating housing markets, 20% equity can arrive rather quickly. It’s important to note that the 20% stipulation applies only to the amount of the loan, and not to the estimated market value of the home. To clarify, if the initial loan amount was $250,000, and the home appreciates to $350,000, then the total equity will amount to more than 20%, even if the borrower has only paid the mortgage down by $10,000.
FHA Loans Have Different Rules for Mortgage Insurance
FHA mortgages are a popular option for buyers with less-than-perfect credit, but they do carry some additional stipulations. FHA borrowers are required to pay for mortgage insurance for the life of the loan, regardless of equity. Typical FHA mortgage insurance premiums are in the neighborhood of $10 per month, per $100k borrowed, but the exact numbers vary depending on the borrower’s situation. Because of this requirement (and the additional 1.75% up-front premium), most borrowers will save money in the long run by opting for a conventional mortgage over an FHA loan.
Does Mortgage Insurance Automatically Cancel?
For traditional mortgages, the lender will typically cancel the mortgage insurance when the loan to value ratio (outstanding debt / home value) reaches 22%. However, it is possible to request a cancellation at 20%.
Is Mortgage Insurance Tax Deductible?
The answer to that question, at least for the time being, is “yes.” But that could change. Mortgage insurance premiums have been tax-deductible since 2007, but this tax provision may have changed since then. It seems likely that lawmakers will renew it as they have in years past, but it’s best not to assume that will be the case.
Welcome to the World of Homeownership!
The idea of paying for the bank’s insurance may not sit well with some homebuyers, but if you want a home loan and don’t have 20% to put down, then you have to play by the rules. Still, historically speaking, buying a home is a solid investment, regardless of the extra cost of PMI.