A large down payment is sometimes the only roadblock to a home buyer. To help cash-strapped borrowers buy homes sooner, many banks offer mortgages with low down-payment requirements. Generally, banks require a buyer with less than 20 percent down, or a homeowner with less than 20 percent equity, to purchase mortgage insurance. The insurance protects the bank and allows it to recoup losses if you default on the loan. Insurance features and rules vary by bank and loan program.
Banks may offer high loan-to-value programs that allow it to finance more than 80 percent of a home's value. Government-backed loans, such as those from the Department of Veterans Affairs, the U.S. Department of Agriculture and the Federal Housing Administration, have the highest loan-to-value ratios. Only certain banks are approved to make these loans. The VA and USDA offer up to a 100 percent loan to value and the FHA offers up to a 96.5 percent loan to value. A bank may also have its own high-ratio in-house loan program.
The need for mortgage insurance and the type of insurance depend on the loan program. Most banks require private mortgage insurance on their in-house high-loan-to-value loans. The FHA requires mortgage insurance on loans it insures. The USDA and VA do not require insurance, but charge the borrower an upfront guarantee fee instead. Private mortgage insurance, or PMI, applies to conventional, non government-insured loans and mortgage insurance, or MI, applies to FHA loans.
The bank may offer options on how you can pay for the PMI on your loan. Some banks offer lender-paid PMI, which requires you to accept a higher interest that includes the PMI cost. Lender-paid PMI potentially has a lower monthly payment and may result in a larger tax deduction, according to Wells Fargo. Borrower-paid PMI requires that you pay 1/12 of the insurance cost each month, in addition to your loan payment. FHA mortgage insurance is borrower-paid.
The bank may allow you to cancel your mortgage insurance after a specified amount of time. The requirements for cancellation are based on the Homeowners Protection Act of 1998, which allows you to stop paying insurance premiums when you've paid down your loan to a 78 percent loan-to-value ratio. The FHA requires that your bank automatically cancel mortgage insurance when you reach the 78 percent loan to value and you've made payments for at least five years.
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