Everything to know about mortgage insurance

Everything to know about mortgage insurance
Photo by Towfiqu barbhuiya / Unsplash

Mortgage insurance (sometimes referred to as MI or PMI) might be the quiet sentinel on the path to homeownership, subtly deciding who gets to claim the keys. This financial safeguard is crafted to protect lenders, while being paid for by borrowers/buyers, yet it's a vital element for many who dream of owning a home. In our exploration of mortgage insurance, we'll uncover the complexities of this often-overlooked aspect of buying a home, gaining the knowledge needed to make informed decisions. You'll learn when it's necessary and how it could affect your monthly payments, helping you grasp the full cost of your monthly housing payment.

We’ll examine both the advantages and potential disadvantages, helping you to determine if mortgage insurance will be a helpful part of your journey or merely an additional cost. We'll also reveal strategies to reduce or even bypass these costs, offering you a clearer understanding of your options.

The essence of mortgage insurance: What is it really?

Mortgage insurance serves as a protective mechanism designed primarily for the benefit of lenders. Although by protecting a lender’s interest it has also allowed for the creation of ‘low down payment’ mortgage programs. Lenders often require this insurance as protection from potential losses should a borrower with a low down payment default on their mortgage payments. It's a financial product that generally becomes a requirement when the homebuyer makes a down payment of less than 20% of the home's value. At its core, mortgage insurance is about risk management, allowing lenders to approve loans that might otherwise be deemed too risky.

When does mortgage insurance come into play? Several scenarios may trigger its requirement. For instance, with conventional loans, whenever the loan-to-value ratio exceeds 80% (a home buyer is looking to take out a loan for greater than 80% of the purchase price), mortgage insurance is typically mandated. For government-backed loans, such as FHA loans, mortgage insurance can be a standard part of the agreement, regardless of the down payment size. It has become an essential component of the mortgage qualification process, helping homeowners who have not yet saved up a down payment of at least 20% qualify to purchase a home.

The cost: Analyzing mortgage insurance premiums

Mortgage insurance premiums can be calculated as a percentage of the loan amount, with rates varying based on the size of the down payment and the loan type. Research by LendingTree indicates that the monthly cost can range from $30 to $70 per $100,000 borrowed. Time magazine further refines this information, stating that the annual cost of PMI can vary from 0.22% to 2.25% of the mortgage's value. These figures highlight the importance of factoring the cost of mortgage insurance into your housing budget when purchasing a home with less than 20% down. Additionally, there is usually an up-front mortgage insurance payment due at closing that is in the range of 1.75% ($5,250 on a $300,000 loan)

When considering the long-term implications, it becomes clear that mortgage insurance can amount to a significant sum over the life of a loan. For example, on a $300,000 loan with a PMI rate of 1%, the annual cost would be $3,000, or $250 per month. Assuming payment of PMI for 15 years of a 30-year loan term, this could total $45,000 (not even including the up-front payment made at closing). This long-term view underscores the need to understand not just the immediate monthly cost but also the cumulative financial burden.

The impact on your monthly budget needs careful consideration as well. Mortgage insurance adds to the monthly outlay, which already includes principal, interest, taxes, and homeowners insurance. This additional expense can affect your overall budget, mortgage qualification and, therefore, your purchasing power.

Weighing the pros and cons

Though often viewed as a financial burden, mortgage insurance does have its upside. It makes homeownership accessible sooner for those unable to make a large down payment. It acts as a bridge, allowing you to purchase a home without waiting years to save up the traditional 20%. Additionally, some types of mortgage insurance may be tax-deductible, although this benefit is subject to change based on current tax laws and your personal tax situation.

However, the drawbacks are considerable. The Mortgage Reports suggests that PMI adds significant cost to your mortgage, with no direct benefit to you in terms of equity or investment return. Over time, you could end up paying tens of thousands of dollars on top of your mortgage payments, which do not contribute to building your home equity.

The trade-off between mortgage insurance and home equity can be a significant one. Every dollar spent on PMI is a dollar not going into the equity of your home. It represents a cost without a direct return on investment, unlike payments towards the principal of your loan which directly increase your home equity.

Alternatives and strategies to avoid unnecessary costs

There are several strategies you can employ to avoid paying mortgage insurance, the most straightforward being a down payment of 20% or more. However, this isn't feasible for many homebuyers. Here are some tactics to consider:

  • Exploring various first-time homebuyer programs which might offer lower down payment options without PMI
  • Considering a "piggyback" mortgage, where a second mortgage is taken out simultaneously with the first, to cover part of the down payment and avoid PMI
  • Obtaining a down payment co-investment from a company like Crib Equity - We will double your down payment, with no monthly payments, to lower your monthly mortgage cost

Mortgage insurance often represents an essential step toward home ownership, enabling buyers to secure a home with less than a 20% down payment. However, this option will add to the monthly cost of a home, while allowing a buyer to purchase sooner than they otherwise could. The buyer is left to balance the pros and cons of beginning to enjoy the lifestyle and financial benefits of homeownership now versus the up-front and monthly costs of mortgage insurance.

The team at Crib Equity is happy to connect and discuss your needs, our down-payment co-investment program and refer you to licensed loan officers who can help in your prequalification and purchase process.