Don’t Have Enough for a Down Payment? Try Mortgage Insurance

For many would-be homeowners, coming up with a down payment that’s 20 percent of the home loan they want just isn’t possible. And most lenders view a down payment below 20 percent as a sign that the prospective home buyer is a high risk. However, rather than not giving the buyer a loan, a lender may offer an alternative: mortgage insurance.

Mortgage Insurance Basics

Travis Saling, a loan officer with Team Home Loans in California, likens mortgage insurance to auto insurance. With auto insurance, everyone pays into a pool each month. If a customer gets into a wreck, the insurance company uses the pooled funds to cover the cost of repairs. With mortgage insurance, you’ll also pay into a pool to help the lender cover losses and costs if a homeowner defaults on their loan. Mortgage insurance also helps the lender offset risks and allows them to make loans to buyers with smaller down payments. However, how much you’ll pay each month and how long depends on both your individual loan circumstances – like your credit score or down payment amount – and what type of loan you choose.

Conventional Loans

According to Saling, if your down payment is less than 20 percent of the total value of your loan, the lender will always require you to pay private mortgage insurance. There are two types of PMI, borrower paid and lender paid.

With borrower paid PMI, your monthly PMI payments are added to your monthly mortgage payment, and you’re responsible for paying the extra fee each month. However, Saling says, “once you’ve had PMI for two years and your loan balance reaches 78 percent [of your total loan], the PMI will drop off automatically.”

When you choose lender paid PMI, your lender will charge a higher interest rate and use the extra interest payments to cover your PMI. You won’t have a monthly PMI payment this way, but Saling warns, “You’re stuck at the rate forever for as long as you have that loan.” Meaning, unlike borrower paid PMI, the higher interest rate won’t drop off after two years.

FHA Loans

Loans backed by the Federal Housing Authority always require mortgage insurance payments, or MIP — the FHA’s version of PMI. How much you put down upfront will determine how long you pay MIP.  “If you put down less than 10 percent, that mortgage is on your loan for life,” Saling said. ”If you start under 90 percent, then you have to have the mortgage insurance on your loan for 11 years or until you sell or refinance.”

When it comes to paying MIP, the FHA has two fees. First, you’ll pay a one-time upfront fee during closing. After closing, individual payments will be rolled into your monthly mortgage payment.

VA Loans

Loans backed by the U.S. Department of Veterans Affairs do not come with mortgage insurance, regardless of your down payment amount. Instead, VA-backed loans come with a one-time funding fee due at closing. However, not everyone qualifies for a VA loan. To qualify, either you or your spouse must be a veteran of the U. S. military.