Mortgage Insurance – What is PMI and how does it work?

If you've ever had a mortgage loan, you may have been a little surprised to find out that the lending company requires you to have mortgage insurance. Not very many first-time home buyers are aware that most big mortgage companies and the government require borrowers to obtain a mortgage insurance policy to ensure that they will get paid in full if you ever happen to default. You'd be pleased to know that not only does mortgage insurance benefit the mortgage lender, it's also rather beneficial for borrowers. This is because having mortgage insurance allows borrowers to purchase a home before they have accumulated the full 20% down payment. Are you planning to purchase a home soon and currently considering getting yourself covered with mortgage insurance? Perhaps your lender has already notified you that you will indeed have to pay for mortgage insurance. Whatever the situation might be, here's everything you need to know about mortgage insurance and everything that comes along with it to make you a more knowledgeable borrower.

Types of Mortgage Insurance

Generally, there are two basic kinds of mortgage insurance and the type that you will need depends on the mortgage loan you will be getting. These two different types are mortgage insurance purchased from the government and mortgage insurance that covers loans from the private sector. The mortgage insurance purchased from the government is understandably designed for borrowers with an FHA or a VA loan. Mortgage insurance for conventional loans from a private mortgage company is usually referred to as PMI (Private Mortgage Insurance).

Who Needs Mortgage Insurance?

When it comes to private loans, most lenders will require borrowers to carry mortgage insurance if their down payment is less than 20% of the home's value. Normally borrowers are required by lenders to be covered with mortgage insurance until their loan-to-value ratio (LTV) is at least 80%. The loan-to-value ratio is most simply put as the amount of money borrowed divided by the actual value of the home. By regularly paying your mortgage payments, your LTV will eventually start to decrease. As for government loans, mortgage insurance is typically required regardless of the LTV.

How Much Does Mortgage Insurance Cost?

Mortgage insurance rates can vary depending on a number of factors. For example, the lower down payment you provide or a low credit score will subsequently mean you will be paying a higher mortgage insurance premium. For most home buyers, monthly mortgage insurance premiums generally range from around $30-$70 for every $100,000 borrowed. Insurance rates are a little different when it comes to FHA or VA loans backed by the government. For FHA loans, there is an up-front MIP (Mortgage Insurance Premium) and an annual premium which is collected from the borrower on a monthly basis. As for VA loans, borrowers are required to pay an up-front funding fee but do not have to pay an annual or monthly premium. If you have any questions about mortgage insurance premiums or current interest rates, you may want to contact your lender to get a better idea about all of the specific details.

Paying for Mortgage Insurance

Most borrowers pay both their mortgage insurance premiums long with their monthly mortgage payment. In most circumstances, you can just send in one single payment to the lender that covers both the insurance and the loan payment. Some lenders may also allow borrowers to pay their PMI in one lump sum at closing or incorporate the financing of the premium into their loan payment.

Why Do I Need Mortgage Insurance?

Mortgage insurance is usually required by lenders because it protects them in case you are no longer able to make your mortgage payments. If you ever do happen to default on your mortgage loan, the lender will be paid in full by the mortgage insurance.

Ways to Avoid Having to Get Mortgage Insurance

When it comes to conventional private mortgage loans, there are a couple of ways to avoid having to pay monthly mortgage insurance premiums. One of the best ways to avoid paying for mortgage insurance is by providing more than a 20% down payment. This is because you will have more invested in the property which makes the lender more comfortable with your ability and willingness to repay the loan.

When Do I No Longer Need Mortgage Insurance

Once you build up a substantial amount of equity in your home, you can eventually request to cancel your mortgage insurance. Under most circumstances, the lender will not automatically cancel the PMI until you've attained at least 22% equity based on the initial appraisal value. As a matter of fact, lenders are required by the federal Homeowners Protection Act to cancel mortgage insurance once the amount of money the borrower has paid back equals 22% of the home's purchase price. If you keep track of your payments and realize that you have reached at least 20% equity, you can also contact the lending company yourself to request your PMI to be canceled. Once it is canceled, you can then invest the extra money into building even more equity in your home to one day make a rewarding profit when it's time to sell. On the other hand, FHA-insured loans require borrowers to pay mortgage insurance premiums for the full life of the loan. The mortgage insurance premiums for FHA loans can never be canceled and if necessary, borrowers will have to refinance the loan.

Hopefully you now have a better understanding of what PMI is, why it's necessary and what it covers. While it may seem a little expensive, there really is no question that getting covered with mortgage insurance is a good idea even if you're not necessarily required to have it. Although, if you want to avoid having to pay monthly mortgage insurance premiums, you should probably create a savings account to save money that will add up to more than a 20% down payment. If you happen to have any further questions regarding mortgage insurance as it pertains to either private or government loans, you may want to contact your lender for information applicable for you and your loan type.

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