How much mortgage insurance you need to pay (And why is that important?)

by Greg on December 29, 2018

Post image for How much mortgage insurance you need to pay (And why is that important?)

Buying a new house can be a daunting experience, particularly if it is your first time. In order to make the best of it, it requires planning and careful calculations. One of the costs to consider is mortgage insurance. Thus, it is important to understand what this insurance is and how it works.

Here you will find an explanation of this important payment, which will help you understand its inclusion when getting a mortgage.

What is mortgage insurance?

Mortgage insurance is a type of insurance cover that you are required to take if you are taking a home loan and you cannot make a 20% or higher down payment on the value of the loan. However, be aware that in some cases, private non-bank lenders also require this insurance for every loan, irrespective of the value of your down payment.

This insurance option covers the lender in case that you default on the loan. Therefore, by reducing the default risk, it allows the lender to provide you with larger loans at lower interest rates. Moreover, if you default on the loan, the mortgage insurer will cover your debt, and then, claim the money back from you.

Why is it important?

Basically, the mortgage insurance increases the mortgage holder’s stake in the property to at least 20% in the eyes of the lender. This is because this insurance policy covers the lender, not the borrower. For the lender, the loan-to-value ratio is now reduced to at least 80%, as the insurance policy assures him the necessary 20 %.

In order to understand this concept better, imagine that your down payment is 3 % of the value of the property. Thus, your loan-to-value ratio is 97 %. Now, your lender requires that you take mortgage insurance, thus, covering the necessary 20% down payment. In their eyes, your loan-to-value ratio has reduced to 80 %, making you eligible for the loan.

How much it costs?

Mortgage insurance costs anywhere from 0.20% to 1.50% of the balance on your loan each year. The value is determined based on your credit score, down payment and loan term. Then, the annual cost is divided into 12 monthly premiums and calculated with your monthly mortgage payments.

Once your payments cover the minimum 20 % of the property value, or the value of the property has appreciated enough, you can cancel the mortgage insurance coverage. Usually, you will have to keep it for a minimum of two years.

So, let’s say that your property is valued at $100,000, and that your down payment is 5 % or $5,000. Then, you are required to take mortgage insurance from the lender. You start paying your loan back, and after two years you have paid an amount of $15,000 or more, and the property hasn’t depreciated. Thus, your debt is 80% of the value of the property. You can now ask for the cancellation of the mortgage insurance payments.

What happens if I add a second mortgage?

If you take a second mortgage on the property, such as a home equity loan or home equity line of credit, your equity on the property is reduced, and if your equity reduces to less than 20 %, you may be required to keep your mortgage loan.

Let’s say your home is worth $100,000, and you owe $80,000 on your first mortgage. That gives you 20% equity, or $20,000. Now you decide to add a second mortgage for $5,000. Your equity drops to 15 %, making you ineligible to cancel your mortgage loan.

How can you avoid it?

One way to avoid the mortgage insurance requirement is to put a mortgage on a second property for the 20 % down payment. In this manner, the lender is covered in case you default on the loan, and may not require you to take mortgage insurance.

Once more, let’s see this with an example. Let’s say that your wife or partner has a property valued at $200,000, and you are applying for a mortgage for a property valued at $100,000. If you cannot afford the $20,000 minimal down payment, you could get a mortgage on her property for the required $20,000, and thus increase the stake in your property to the minimum 20% in the eyes of the lender.

{ 0 comments… add one now }

Leave a Comment

Previous post:

Next post: