If you’re looking to take out a mortgage and have less than 20% to put down, it’s likely that you’ll need to pay mortgage insurance. Particularly with today’s housing and mortgage crisis, banks are careful to weigh the risks and want to be sure their investments are protected. If you’re curious about what mortgage insurance is and why you need to have it, read on.
Mortgage Insurance Basics
Unlike homeowners insurance, car insurance or other property insurance, mortgage insurance isn’t a policy you pay for to protect your own assets. It’s a policy that you pay for to protect the interests of the lender. Most banks realize that it’s risky to lend to a borrower who does not have enough collateral. Enter mortgage insurance. The mortgage insurance company agrees to share the risk with the bank in exchange for monthly mortgage insurance premiums which are paid for by the borrower. In the event that you default on your mortgage, the insurance company will pay the bank a certain % of the value of the mortgage depending on the policy you were required to purchase. In this way the bank limits its liability when it lends to borrowers who do not put a large amount down.
Why You Need Mortgage Insurance
If you don’t have at least 20% to put down, you need mortgage insurance to get a mortgage loan at all. There are a few circumstances where you can avoid paying mortgage insurance but they generally require a 2nd mortgage in the amount of at least 20% of the property value. Since 2nd mortgages typically carry a much higher interest rate, double check to see if the cost savings of not paying mortgage insurance outweighs the added interest expense of a 2nd mortgage.
How Much is it?
For FHA loans, most borrowers are required to pay 1.75% of the loan amount. This amount is usually financed and packaged as part of the loan. If you have a very high loan to value ration you may also be required to pay an additional monthly fee.
How Long Do You Have to Pay For It?
It depends on the specifics in your contract but there are some general guidelines. In most cases you need to pay the insurance for a minimum of one year. If you have an FHA loan, you’re likely looking at 5 year minimum. Additionally, most loans require that you have at least 20% equity before you can request to have it removed. The request also must be in writing.
Recently the IRS has determined that mortgage insurance can be deducted from your annual income taxes just like mortgage interest. While this doesn’t eliminate the sting of a higher monthly payment it does mean some tax savings each year that you have to pay it. Remember to take the deduction when you file taxes
At first mortgage insurance seems like an unnecessary expense. However, it’s important to realize that without mortgage insurance, borrowers who have less than 20% to put down would likely not be able to qualify for a loan at all. So while mortgage insurance is an added monthly expense it does make it possible to have a home with a lower down payment.