Do you need mortgage insurance?
Ready to buy your first home? When figuring out what you can afford to spend on a home, mortgage insurance is an important number you need to factor in. Mortgage insurance may be required to get a home loan, depending on the size of your down payment and which type of mortgage you're getting.
Should I get mortgage insurance?
Mortgage insurance is designed to protect your lender in case you default on your home loan. Whether you should get mortgage insurance or will be required to have it, depends on the terms of your loan.
If you're buying a home with a conventional mortgage, for example, you'd likely need to pay private mortgage insurance (PMI) if your down payment is less than 20 percent of the purchase price. FHA loans and USDA loans, which are government-backed mortgages, also require you to pay mortgage insurance premiums for the life of the loan. The actual premium you pay depends on the loan type, loan terms, and your risk level, said Matthew Posey, a certified mortgage planning specialist with Axia Home Loans.
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This type of insurance is different than mortgage protection insurance or mortgage life insurance. This type of mortgage insurance covers you, not the lender, and purchasing a policy is optional.
What does mortgage insurance cover?
PMI and mortgage insurance for government-backed loans protects your lender. For example, if you can't make your payments because of a job loss, illness or any other reason, this coverage kicks in and allows your mortgage lender to recoup losses if the home has to be sold in a foreclosure proceeding.
Essentially, you're paying money on top of your regular mortgage payment to make sure the lender has a safety net if you can't make good on your loan. Mortgage insurance premiums are added onto your regular monthly mortgage payment annually and a one-time upfront premium may also be required.
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Mortgage protection insurance covers you and helps to pay off your mortgage if you become disabled or pass away. So if you were to die suddenly, any remaining amount owed on your home loan would be paid off. The policy's coverage shrinks as your mortgage balance goes down, so it's not the same as a traditional life insurance policy.
Pros and cons of mortgage insurance
If you're debating whether to get a home loan with private mortgage insurance, it helps to look at how it could help or hurt you.
Pros of mortgage insurance:
- Could help with your eligibility for a mortgage loan if you can't afford a bank's 20 percent down payment requirements.
- PMI on conventional loans can be canceled once you reach 20 percent equity in the home.
- Mortgage life insurance policies can help your loved ones stay in the home if something happens to you.
Cons of mortgage insurance:
- PMI increases your monthly mortgage payments.
- Mortgage life insurance may offer less coverage and a higher cost compared to traditional life insurance.
- Mortgage life insurance policies may come with numerous exceptions in which your coverage wouldn't apply.
One additional benefit of having mortgage insurance is the potential to get a lower interest rate. "The rate provided will typically be lower because the mortgage insurance protects the lender, thus relieving some of the risk within the loan," Posey said.
How to avoid mortgage insurance
The simplest way to avoid private mortgage insurance when buying a home is to offer a 20 percent down payment. That may be easier said than done, however, if you're trying to save for a home while also paying down student loans or other debts.
In that case, it may be helpful to consider alternative ways to raise the down payment money you need. For example, you might consider:
- Down payment assistance. Down payment assistance programs offer help with down payments and closing costs for qualified buyers.
- Down payment gifts. Banks and mortgage lenders will allow you to buy a home with down payment money gifted from family members if you have proper documentation.
- Tapping retirement savings. You can withdraw up to $10,000 from an IRA toward the purchase of a first home penalty-free.
Since mortgage life insurance is optional, there's nothing special you need to do to avoid it. But if you're considering buying a policy, compare the cost and coverage to a regular life insurance policy first to see which one could yield more benefits.
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And if you do end up with PMI on your mortgage, be aware that there are multiple companies that provide this coverage. Since premiums can vary, it's important to know which company your lender uses, said Posey.