Mortgage Insurance
One of the biggest concerns for mortgage lenders and borrowers alike is the idea of loan default. Mortgage lenders provide large amounts of money to homebuyers, and if the loan payments are not made, the lender may end up with a significant loss. As a result, it is common for lenders to require some sort of mortgage insurance as a safeguard in case of default.
Mortgage insurance protects the lender in case you fail to make the mortgage payments. In general, if your down payment is less than 20% of the home’s purchase price, you will be required to purchase mortgage insurance. Mortgage insurance usually costs around 0.5%-1% of the total loan amount, which is added to your monthly mortgage payments for the year. A mortgage loan may be insured through the government or through the private sector (i.e., private mortgage insurance, or PMI).
At some point during the homebuying process, your lender will order an appraisal of the home to determine its market value (before officially approving your loan). Most lenders do not approve mortgages for amounts that exceed 90% of a home’s appraised value ― also known as the “loan-to-value ratio” or LTV. As you pay down the mortgage, your LTV ratio will decrease to a point at which the mortgage insurance can usually be cancelled. Make sure to ask your lender about terminating mortgage insurance when you reach the required LTV ratio, or you could be making unnecessary payments.
An alternative to paying mortgage insurance is to take out a second loan (a.k.a. piggyback loan) to bring the first mortgage down to 80% of the purchase price. If possible, the best solution for avoiding mortgage insurance is to make a large down payment. However, it is very difficult for most borrowers (especially first-time homebuyers) to assemble such a large sum of money.
Mortgage insurance is not necessarily a bad thing ― it may actually help you get approved for a loan since it reduces the lender’s risk. Just make sure that you understand the payment plan and keep track of your LTV ratio so the mortgage insurance can be cancelled as soon as you’re eligible.