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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.

Tax Deductible
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.

Interest rates are at a historic low. If you purchased your home several years ago at a higher interest rate this is the time to look at your refinancing options. Refinancing doesn’t make sense in all circumstances however. Our checklist below will help you determine whether or not you’re a good candidate for a refinance.

The Equity Question
First, you need to determine if you have equity in your home or if you’re in an underwater situation. You can use sites like Zillow to determine whether or not your home is worth more than what you paid for it. Most banks will refinance up to 100% of the home’s value and some will go as high as 125%.

How Much Can You Save?
The cost savings in interest rates can be astounding. For the sake of this example, let’s assume a $250,000 mortgage at a fixed rate for 30 years. At 7% payments would be $1663 and the total interest you would pay over the life of the loan would be $348,000. At 4% payments would be $1193 and total interest payments would be $179,000. That 3% difference makes a $470 a month difference in payment and you save $169,000 in interest!

Costs and Break Even Timeline
Banks make money on mortgages in two ways. The first is the interest you pay on the loan. The second is the fees that you pay when you take out a loan. These fees can be called a number of things – points, loan origination fees and document fees. Before you decide whether or not to refinance you need to investigate what likely refinance costs will be.

If you prefer to work with a local lender, credit unions generally offer the best rates and lower fees. Make a few phone calls to determine what local closing costs would likely be. Then compare local rates and closing costs to what is being offered online.

Once you know how much it will cost in fees, you can determine how long the savings you’ll receive with the lower interest rates will take to pay off the costs you’ve incurred to refinance. If you plan on being in your home for a long period of time it usually makes a lot of sense. If you tend to move every few years however it may not make sense. Even if the costs involved do take a long period of time to break even on, it can still make sense to refinance if you need a lower monthly payment.

There are also a large number of homeowners who find themselves in a situation where they do not have enough equity to qualify. In that situation the only thing you can do is work to build equity and hope the interest rates stay low long enough for you to take advantage of them.

With interest rates in the low 4’s, chances are it will make financial sense for you to refinance. Rates can’t get much lower – take some time to talk with your lender to investigate whether you can save hundreds each month and thousands over the life of your loan.