Mortgage Insurance – What it is and How to Avoid It
Mortgage insurance or Private Mortgage Insurance, by definition, is insurance against a borrower's default, or insurance that a lender obtains against non-repayment of mortgages. In simpler terms, it is insurance that a borrower will pay to a bank, so that the bank is protected against sudden loss and non-payment by said borrower. It might not sound like the most exciting form of insurance, but for some home buyers it is the helping hand they need to get into a home. Traditional conventional financing on a purchase will typically require a 20% down payment, for some buyer-hopefuls this is not an affordable program. Mortgage insurance allows borrowers to attain a home loan for as little as a 5%, 3.5% or even 0%-down payment.
On a low down payment loan program, mortgage insurance will be added on to your loan principal to protect your lender against non-payment in the unfortunate event you default on your home loan. Mortgage insurance is solely in place to protect the lender, not the borrower. Mortgage insurance is often required by lenders on these loans because of the higher risk level of defaulting that is intrinsically associated with lower down payment loans. Therefore, the only real benefit to having mortgage insurance is to get a home loan with a low down payment option.
So how can you avoid it? Save up a down payment of at least 20% of the purchase price and your mortgage program should not require mortgage insurance. Think of it as a show of good faith to your lender; borrowers willing to pay upfront a sizeable chunk of the cost of their home are less likely to default on their loan, because they have already invested so much into their home. Banks like to see down payments towards mortgages and will not ask that a borrower pay towards what is basically insurance against loss, if the borrower is willing and able to make a 20% down payment.
Another way to avoid paying mortgage insurance is to finance the loan with 80% of the loan amount on one fixed mortgage, and then finance the remaining 20% of the loan amount on a second mortgage. A 20% second mortgage removes 20% of the risk from the first bank’s mortgage risk and can therefore allow you to avoid paying mortgage insurance. Second mortgages can also be structured as a Home Equity Line Of Credit (HELOC), which provides an easy way to borrow against the equity in your home in the future without having to apply for a new loan.
If you are unable to pay a 20% down payment on your home loan or if you are unable to secure a 20% second mortgage, you will almost definitely be paying mortgage insurance. However, there are ways to eventually eliminate your mortgage insurance. To become eligible to remove mortgage insurance, you need to show that your home has reached an 80 percent loan-to-value ratio. In other words, your home’s market value needs to be at least 20 percent higher than what you owe towards your loan. You can have an appraisal performed if your home value has risen over the years, or a faster option may be to remodel and make enough improvements so that your home’s value increases and reaches that 80 percent loan-to-value level. You can even pay more towards your mortgage each month to reach that value faster, as opposed to making your normal monthly payments. Even little additional payments will add up quickly over time. And of course, if you are not worried about terminating your mortgage insurance early, you are always eligible for automatic termination; once you have paid enough towards your mortgage and you have reached a 20 percent equity towards your loan, you can request to have the mortgage insurance removed. The 80 percent loan-to-value mark is the magic number to keep in mind.