Agreeing to buy private mortgage insurance (PMI) through your mortgage lender may allow you to take out a home loan for only a nominal 1% or 2% down payment. The mortgage insurance will satisfy your lending institution because if you are unable to repay the mortgage loan, they will be insured for the loss. However, the monthly or yearly premiums you pay on the mortgage insurance may cost you quite a bit as time goes on.
A typical premium rate on private mortgage insurance is a percentage, less than 1%, of the loan balance. Some rates will decrease after a period of time if not yet paid off. It is important to know that once you have paid off 20% of the value of your house, through a combination of down payment and mortgage payments, you will no longer need to pay mortgage insurance. Thus, it may be helpful to divide your mortgage loan into two parts ― a smaller part that takes into account your interest rate and your mortgage insurance payments, and a larger part that just includes your mortgage payments after your mortgage insurance has been cancelled.
Calculate how much each of these parts will cost you over the life of your mortgage loan (say 20 years) and add them together, and compare that number to what it would cost you to accept a higher interest rate from your lender instead of mortgage insurance. (Your lender will use the additional income from your higher mortgage rate to purchase mortgage insurance themselves, sometimes at a profit.) Take into account that mortgage interest is tax-deductible, but mortgage insurance premiums are not.
Also keep in mind that if you obtain your mortgage loan through the Federal Housing Administration (FHA) you may qualify for a lower mortgage rate. You will, however, need to pay government mortgage insurance premiums (which are typically smaller than the premiums on private mortgage insurance) as well as a relatively small down payment on the home.
You must have an acceptable debt-to-income ratio as determined by the FHA in order to qualify for an FHA loan. Your credit and payment history on debts may also come into play. Another advantage to FHA loans is that a home appraisal is done by an FHA inspector. It is important to know the value of your home, because if your home value increases due to home improvements or other factors, you may be eligible to cancel your mortgage insurance sooner.