When you're buying a home, the last thing you want to learn about is yet another cost you'll encounter. You would think that after the appraisal, title insurance and title company fees, loan origination fee, down payment, and escrow account deposit, you would have spent enough. However, you may be required to pay for mortgage insurance as well, which protects the lender financially if you default. Learn the requirements in advance so you can prepare for this cost or avoid it if possible.
Private Mortgage Insurance on Conventional Loan
Lenders for conventional loans are required to include mortgage insurance on loans for more than 80 percent of the purchase price of the home. This requirement comes down from Fannie Mae and Freddie Mac, the companies that back the mortgages. Private mortgage insurance costs vary, but are often between 0.5 percent and 2 percent of the initial mortgage amount per year. Private mortgage insurance payments are cancelled when your remaining mortgage amount is less than 80 percent of your original purchase price, provided you have made all of the mortgage insurance payments as agreed.
Mortgage Insurance Premiums on FHA Loan
All FHA mortgages require the borrower to make an upfront mortgage insurance premium payment. However, you can choose to finance this payment by adding it to what you are borrowing. The amount of the upfront payment is 1.75 percent of the loan amount, regardless of your down payment amount or length of repayment term. You also need to pay annual mortgage insurance premiums of 0.35 percent to 1.5 percent of your original mortgage amount on most FHA loans. The exception is a 15-year mortgage with a down payment of at least 22 percent of the purchase price, which has no annual mortgage insurance premiums. You can cancel your FHA mortgage insurance premiums once your mortgage balance is 78 percent of the purchase price and you have made at least five years of mortgage payments. However, five years of payments are not required on 15-year FHA mortgages.
Lender-Paid Mortgage Insurance
One final type of mortgage insurance is lender-paid mortgage insurance, which some banks offer on conventional mortgages. It is an alternative to private mortgage insurance for loans of more than 80 percent of the purchase price. With lender-paid mortgage insurance, you take a slightly higher interest rate on the mortgage and in return, the lender pays the mortgage insurance on your behalf. This often results in lower payments at first than you would have on a mortgage plus traditional private mortgage insurance, but you have to make the payments for the duration of the loan, rather than stopping when your balance is less than 80 percent of the purchase price.
Ways to Avoid Mortgage Insurance
Mortgage insurance payments eat into your income, so you should avoid them if possible. The easiest way to do this is to save until you can put 20 percent down on a conventional loan. If putting 20 percent down will wipe out your savings, you can consider including a seller rebate to cover closing costs in your offer so your costs there aren't as high. Another option is to ask your parents for assistance with a down payment. Most banks will allow you to receive part of your down payment as a gift, although they may require documentation.
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