Is Mortgage Insurance Required?
You probably know about homeowners insurance because you're ready to be a homeowner. Besides, you want to ensure that nice, new dream home. But mortgage insurance? What and why and how come? And who is it for, anyway?
Why a Lender Charges Mortgage Insurance
It turns out that mortgage insurance isn't really for you, at least, not directly. It's for your lender, and you have to pay it if your down payment is less than 20 percent of the home's price. "It allows the lender to feel more comfortable lending to borrowers who put down a smaller down payment," says Claude L'Heureux, senior vice president of residential lending at Illinois-based Community Bank of Oak Park River Forest.
In other words, to the bank, a smaller down payment represents a riskier loan. When you receive your loan estimate from the bank, prior to your closing, you'll see a line item for private mortgage insurance (PMI), if your loan is conventional, or mortgage insurance premium (MIP) if your loan is through FHA. Unlike car or homeowners insurance, you don’t shop around for this; your lender will make arrangements for you.
Every month, part of your mortgage payment will include a fee for your mortgage insurance. You can expect a fee to range from 0.3 percent to 1.5 percent of your loan amount per year. The rate depends on your credit score, the size of your down payment and the type of loan you chose. As you can probably guess, a bigger down payment, a higher credit score, and a shorter-term loan all contribute to a lower rate. Some years and at the discretion of Congress, PMI premiums are tax-deductible.
Shaking it Off
For a borrower paying on an FHA loan, the obligation to carry mortgage insurance lasts for the life of the loan. But good news for those paying on conventional loans: As you pay down your mortgage, you’ll reach a point when mortgage insurance is no longer necessary (big sigh of relief). And that time comes when you reach a loan-to-value ratio (LTV) of 80 percent. LTV is the amount you owe on the home divided by the home’s appraised value. Those who put down 20 percent at closing started out with 80 percent LTV.
To rid yourself of mortgage insurance once the time comes, make your request in writing to your lender. The bank will approve and remove if you have a good payment history, are up to date on payments and don’t have a second mortgage on the home.
If you don't ask your lender to cancel your mortgage insurance at the 80 percent point, it terminates automatically when you hit the scheduled 78 percent point, even if your home has dropped in value.