Buy a Home Faster
A down payment is your offer to share the risk of financing your home with the lender by putting your own money toward the purchase. While all loans by nature are risky, borrowers who put 20 percent down, or who refinance with 20% equity in their homes, are considered to be good risks. They have “skin in the game” that they don’t want to lose and that helps protect the lender, too.
Many first-time and low-income borrowers are also good risks, but it would take them too many years to save enough money to buy a home with 20 percent down or more. Many high-income borrowers may have enough cash to put that much down, but they prefer to leverage their credit and use their cash for other purposes.
That’s why private mortgage insurance (PMI) exists. PMI pays the lender in case you default on the loan. By removing risk from the lender, PMI allows borrowers to get into a home quicker without making a large down payment, sometimes for as little as three to five percent down. Loans with PMI are available only on primary residences, not investment properties or second homes. They come with higher costs in your monthly payments, but it may well be worth it to you.
A typical mortgage insurance program is a five-year term, which means the insurance is paid in full in five years. PMI will end automatically when you build 22 percent in equity from paying down your mortgage. This is based on the loan amortization schedule for loans in which most of the monthly payment goes to pay the interest on the loan and to reduce the principal. Once the principal has been reduced to the amount insured by PMI, the PMI is considered paid in full and is automatically removed from the loan.
It’s possible to get your MI removed sooner than five years. Your lender will tell you what is required to remove MI, such as getting a bank appraisal and showing recent sold “comps” provided by your Berkshire Hathaway HomeServices network professional that show your home has increased in market value. But with some types of loans such as FHA loans, which are popular for requiring relatively little money down, borrowers pay MI for the life of the loan with no possibility to cancel the MI except to refinance into a different product. With VA loans, there’s no MI required, but veteran borrowers pay a fee of about 2.15 of the loan amount.
Mortgage interest rates are variable, according to where you live, your credit, terms, and the amount of your down-payment. A low down-payment will result in a higher rate unless it can be offset by excellent credit or some other factor. The alternative to getting a loan with MI is simply pay the bank a higher interest rate, and they pay the MI, but keep in mind that interest rates never go down unless you are able to refinance the loan to a lower rate.
Should you be concerned if you can’t afford to buy a home without MI? No. Just think of it as part of the interest rate. Because you have less skin in the game, the lender wants to make sure the loan will be paid in case of default. MI provides that assurance.