When buying a home, your clients don’t always need to put down 20 percent of the sale price. Some lenders will approve a down payment of 15 percent or lower, while Federal Housing Administration (FHA) loans only require 3.5 percent down. Moreover, United States Department of Agriculture (USDA) and Veterans Affairs (VA) loans are both zero-down loans.
However, regardless of the lender, if your clients put less down than 20 percent, they’ll have to purchase mortgage insurance. But what is this exactly — and how does it work?
How Mortgage Insurance Works
A lender will require mortgage insurance if your clients make a down payment that’s less than 20 percent of the home’s sale price — in other words, if the lender is financing more than 80 percent.
What’s so important to understand is that mortgage insurance protects the lender in the event your clients default on their home loan — not the homeowner. If your clients fail to pay their mortgage payments, the home will eventually go into foreclosure. As SFGate explains, the lender will file a claim with the insurer for the amount of the loan that isn’t recovered in the foreclosure process. Remember: Even though the homeowners pay the premiums, they never receive a payout on mortgage insurance.
Since lending institutions fall into two categories, private and public, there are also two categories of mortgage insurance.
Private lenders like banks require private mortgage insurance, or PMI. Realtor.com explains that in general, PMI premiums are between 0.3 percent and 1.15 percent of the home loan. Note that your clients’ credit scores will impact the premium amount. Premiums can be paid at closing, in monthly installments or rolled into the mortgage, depending on the lender’s terms.
According to the Consumer Financial Protection Bureau, government lenders have varying requirements. The FHA always requires mortgage insurance, which is partially paid upfront and partially in monthly installments. The USDA’s mortgage insurance is typically less expensive. A portion is paid at closing, and a portion is paid in monthly installments. A VA loan has a VA guarantee instead of mortgage insurance, and it’s paid at closing. All three government lenders allow the upfront fee to be rolled into the mortgage, but the result is that it increases the monthly payments and overall costs.
Example of How PMI Works
Let’s say your clients want to take out a 30-year mortgage for $165,000 with a fixed interest rate of 4.55 percent to purchase a $200,000 property. They have a very good credit rating. Since the initial loan to value (LTV) ratio is 82.5 percent, they’ll need PMI. This would cost them approximately $31 per month for 40 months, at which point they’ll have achieved 20 percent equity in the home. Then they can ask the lender to cancel the PMI. If it’s an FHA loan, the PMI lasts for the term of the loan — but your clients can always try to refinance with a different lending institution
Do the Math Before Making a Purchase Decision
Mortgage insurance could be a way for your clients to purchase the home they want. However, the monthly costs can add up substantially — and that money isn’t going into their investment. That’s why before making a purchase decision, they’re best advised to calculate how much the mortgage insurance will cost them until they have sufficient equity in the home to cancel it. Because in some cases, it simply makes more financial sense to wait longer and save more money for the down payment on a different home.