If you are preparing to buy your first home, the number of acronyms and terms you’re hearing can start to run together and feel overwhelming. One term that you may see mentioned is “mortgage insurance” and more importantly, you may be left wondering if it’s something you’ll need. We are always here to help simplify the mortgage process, giving you confidence to invest and reach your real estate goals.
What is mortgage insurance?
Mortgage insurance, often referred to as PMI (private mortgage insurance), is a type of insurance that is designed to protect the lender so that they can offer a loan with a lower down payment without taking on too much risk. It is typically required when the borrower makes a down payment of less than 20% of the home’s purchase price.
Mortgage insurance allows borrowers with smaller down payments to obtain a mortgage loan without having to provide a larger initial deposit. Instead, the borrower pays a small monthly mortgage insurance premium, which pays for an insurance policy that would protect the lender if the borrower defaults on the mortgage.
The primary purpose of mortgage insurance is to protect the lender, not the borrower. It provides a level of security for the lender in the event of default, reducing their financial risk. By transferring some of the risk to an insurance company, lenders are more willing to offer loans to borrowers with a higher loan-to-value ratio (LTV). This is still great news for you as a borrower because it means buying your first home faster, without the need to save 20% for a down payment.
Do I need mortgage insurance?
In most cases, you will need mortgage insurance if you plan to put down less than 20%. There are some exceptions to this, like VA loans. For nearly all first time home buyers, the increased monthly cost of mortgage insurance is far more affordable than saving up the bigger down payment.
When can I stop paying for mortgage insurance?
In some situations, mortgage insurance can be canceled or removed after a certain amount has been paid. For loans backed by the Federal Housing Administration (FHA), mortgage insurance premiums are required throughout the loan term. However, for conventional loans, mortgage insurance can be canceled when the loan-to-value ratio reaches 80% or less, either through a reduction in the outstanding loan balance or an increase in the property’s value.
For example, let’s say you bought a $500,000 home with a 3% down payment of $15,000 with a conventional mortgage. Mortgage insurance would need to be paid until the LTV reaches 80%, which means the amount you owe on the home is less than 80% of the value of the home. This might be reached simply by paying your monthly mortgage until you have paid down an additional 17% of the premium, but there are other ways to reach 80% LTV, too. If the value of your property increases because of a growing market or home improvements, you may reach 80% LTV much faster.
We understand that buying your first home is complex, and understanding all of the new terms can be exhausting. We’re here to help. Ready to learn more about buying your first home in California? Contact us any time.