If you’re preparing to buy a house, you may or may not have heard about mortgage insurance. Keeping your house payment as low as possible has a tremendous impact on affordability, and when estimating your home loan payment, you probably factor in the purchase price, the interest rate, taxes and insurances. But if you put down less than 20% on a home purchase, there is another expense to worry about.
Just hearing the words “private mortgage insurance” can invoke a collective sigh in homebuyers. Unlike other types of insurances associated with your property, mortgage insurance only benefits your lender. Lenders no longer require huge 20% down payments, and because of this, private mortgage insurance protects them if you default and stop paying the home loan. From their standpoint, this makes good financial sense. And while mortgage insurance increases your monthly payments, there are benefits to you as well.
Consider this: how long would it take to save a 20% down payment? If buying a $200,000 house, that’s approximately $40,000. And even if you could save this much, you may hate the idea of wiping out your bank account simply to purchase a house. With mortgage insurance, you don’t have to sacrifice liquidity. You can buy a house and put down as little as 5% for a conventional loan.
But you may ask, how much is mortgage insurance, and am I paying too much?
Both are common concerns, and to make sure that you’re getting the best possible loan, it’s smart to question your costs. Mortgage insurance varies by lender, but the annual cost typically runs between .05% and 1% of your loan balance. If you’re buying a $200,000 house you can expect to pay about $2,000 a year for mortgage insurance.
Understand, however, that certain factors can increase how much you pay for mortgage insurance – it all depends on whether you’re a good or risky loan applicant. For example, borrowers with low credit scores and high debt to income ratios may pay more for mortgage insurance, a percentage determined by the lender. High mortgage insurance can add hundreds to your mortgage payment each month, which can greatly impact affordability.
Fortunately, there are no surprises with regards to mortgage insurance, as lenders list the cost of mortgage insurance on a good faith estimate, which is a form that outlines the terms of a mortgage loan plus costs related to the mortgage. This might not be the exact costs, but it’s a pretty close estimate.
Carefully reviewing your good faith estimate lets you know what to expect, and if you feel that you’re paying too much for mortgage insurance you can take steps to reduce your costs. For example:
1. Shop around and get quotes from other lenders. Again, mortgage insurance costs vary greatly. One lender may charge 1% of the loan balance, whereas another lender charges .05%. If you think you can find cheaper insurance elsewhere, shop around and compare your options.
2. Increase your credit score. If your cost for mortgage insurance is higher than normal due to bad credit, perhaps now’s not the best time to purchase a home. Postponing your purchase and improving your credit score can result in cheaper mortgage insurance , thus saving your thousands over the course of your mortgage loan.
3. Make a larger down payment. The easiest way to avoid paying too much for mortgage insurance is to make a larger down payment. Even if you can’t put down 20%, maybe you can put down 10% or 15%. This doesn’t eliminate PMI, but the more you put down, the less you pay for mortgage insurance. And since lenders drop mortgage insurance once you have 20% equity, a larger down payment helps get rid of this insurance quicker.
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