When you buy a home, there are a number of costs that you need to bear in mind. When you consider loan application fees, closing costs, and property maintenance expenses, you can see that the costs of buying a home add up pretty quickly. One of the expenses that might surprise you is mortgage insurance.
What is Mortgage Insurance?
When you purchase a home, the mortgage lender provides funds for that purchase and you agree to repay the loan based on predetermined terms. If you default on the loan, the lender may not get their money back ― especially if your home ends up in foreclosure and is sold at a discounted price. In order to help limit their risk, the lender will require you to pay for mortgage insurance.
Depending on the type of loan, you may get private mortgage insurance (PMI) or government mortgage insurance. The insurance can usually be cancelled once you’ve paid down a certain amount of your loan. However, if you can make a sufficient down payment at the start (usually 20% or more), you may not be subject to mortgage insurance at all.
Creatively Avoid Paying Mortgage Insurance
If you do not have the money for a 20% down payment, there is another way you can avoid paying mortgage insurance. Some lenders will allow you to get a “piggyback loan” when you buy the home, which is basically a second mortgage that brings your first mortgage down to 80% of the home’s purchase price (considered equivalent to a 20% down payment).
For example, a house with a price of $175,000 would need a $35,000 for a 20% down payment. If you only have $20,000 saved up, you will have to pay for mortgage insurance. However, getting a piggyback loan for $15,000 (to make up the difference in the down payment) could help you avoid the mortgage insurance. Keep in mind, though, that lenders have been much less willing to forego mortgage insurance since the economic downturn.
You should note that, in many cases, the piggyback loan will have a 30 year loan term (just like your first mortgage). You will probably have to pay-off the second loan while you’re simultaneously making regular mortgage payments. Additionally, the interest rate on a second loan is often higher, which could actually cost you more in the long run than if you’d simply paid for mortgage insurance.
In some instances where it may be impossible to avoid mortgage insurance, borrowers should also remember that the insurance can be cancelled once you’ve repaid a certain amount of your loan.