Mortgage insurance, commonly known as PMI (Private Mortgage Insurance), plays a pivotal role in the path to homeownership, offering a lifeline to those who haven't stashed away a hefty 20% down payment. For many, especially first-time homebuyers, scraping together $10,000 or more, depending on the home's price, can be a daunting challenge. Picture needing $100,000 for a $500,000 home—far from feasible for most newcomers to the housing market. This is where mortgage insurance steps in to bridge the gap.
Lenders, cognizant of the difficulties borrowers face in making substantial down payments, introduce mortgage insurance on select loan types, such as FHA or VA loans. This insurance serves as a safeguard for lenders, necessitated by the reduced down payment. It's known as Private Mortgage Insurance or Lenders Mortgage Insurance.
Why do lenders insist on mortgage insurance?
They want to mitigate their risk in case a borrower defaults on the loan, which, statistically, could be more likely when a 20% down payment is out of reach. Whether it's a genuine concern or not, lenders still need to recoup their losses if a borrower defaults.
It's important to note that mortgage insurance primarily protects the lender, but it can also be a boon for the borrower. It allows for down payments below 20%, enabling countless aspiring homeowners to achieve their dreams sooner. However, the borrower is responsible for covering the premium.
Greg Dallaire, Green Bay Realtor says, "The cost of mortgage insurance hinges on factors like the mortgage amount, loan terms, down payment size, credit score, and history. On average, you can expect to pay around $50 per month for every $100,000 borrowed." Dallaire says, "You can pay premiums upfront or roll them into the loan. Some insurers may offer discounts to borrowers with modest incomes or larger down payments, but it's wise to discuss these options with your lender." [source]
One silver lining is that mortgage insurance isn't a lifelong commitment. It's mandatory only until your loan's principal balance reaches 80% of your home's value—ironically, the same threshold you'd reach if you'd initially put down 20%.
In 1998, the US Homeowners Protection Act mandated lenders to cancel borrower-paid mortgage insurance once the loan hit 78% of the appraised value or the sale price, whichever is lower. This means you'd typically need to hold 22% equity in your home for automatic cancellation. However, borrowers can request cancellation after a year or two of payments or if the home's appraisal hits 80% of the loan.
An additional perk is that private mortgage insurance is tax-deductible and often the most cost-effective option for low-down payment borrowers. Keep in mind that Congress reviews this tax break annually, so consult your lender to confirm its availability each year.
In conclusion, private mortgage insurance can be a lifeline for borrowers who can't muster a 20% down payment. However, don't forget to cancel it as soon as you're able, so you're not needlessly paying for coverage you no longer require on your homeownership journey.