When you take out a mortgage, a 20% down payment is often required as your part of the equity. However, there are instances when you can take out a mortgage loan even if you can only commit to a lesser down payment (even as low as 3% in some cases). However, in these cases, the mortgage lenders will require you to get mortgage insurance. Your lender will walk you through the specifics for them; the reason why it’s required is that you’ll need it to help you secure the loan program that works best for you.
What is Mortgage Insurance?
Mortgage insurance is a type of insurance that protects the lender in case you cannot pay back your mortgage. A lot could happen that could potentially disrupt the mortgage applicant’s payment such as economic reversals, death, or some other situation that prevents you from being able to pay off your mortgage. However, if there is mortgage insurance, then the lender has an extra layer of security to guarantee the mortgagor’s obligations.
Mortgage insurance is designed to protect the lender and not the borrower, so you’re likely to find it required in loan programs where little or no equity is built in the home upfront. There are a couple of options for acquiring mortgage insurance. You can get private mortgage insurance in addition to your mortgage loan, or you can roll it into your mortgage and make just one payment. Once you’ve made a certain amount of equity in your home, the mortgage insurance may be canceled regardless of the amount of your down payment for both options.
Instances where Mortgage Insurance is required
Low Down Payment
Down payments are in themselves forms of security. By putting a significant down payment, you’re giving notice to the mortgage lender that you’re committed and that you’re in it for the long haul. Hence, if you’re not able to put up the usual down payment, you are not that invested and you may easily decide to abandon the purchase altogether (at least one the perspective of the lender).
To appease the lender’s doubt, mortgage insurance is required. The amount of insurance required and the rate will depend on a few factors, like credit score, amount of the loan, and the amount of the down payment.
FHA loan is a type of mortgage loan backed by the Federal Housing Authority and thus they’re one of the entities that can accommodate a mortgage application even if you cannot put up the usual down payment. For as low as 3.5% down payment and a credit score of at least 500-580, you may be able to get a mortgage for a property you’re planning to buy. The catch is that you will need to secure the loan by getting mortgage insurance.
Similar to FHA loans, USDA loans are backed by the government, specifically the Department of Agriculture. They are intended for people who wish to move from urban areas to rural areas. Compared to FHA, USDA is cheaper but you’ll still pay the upfront fee (in place of the down payment) and the monthly premium for your mortgage insurance. You do have the opportunity to roll the upfront fee into the loan for both of these programs, but doing so will increase your loan amount and monthly payment.
VA loans are loans intended for active or retired members of the armed forces. VA loans already have their form of mortgage insurance, called a VA guarantee. The VA guarantee differs from regular mortgage insurance because it has no monthly premium. Instead, the guarantee is paid as an upfront funding fee. The fee is calculated based on a few factors, such as your military branch, down payment amount, disability status, and whether or not this is your first VA loan.
Mortgage insurance’s primary purpose is to protect the lender from any risks they may be put through for financing your dream house. It’s an additional requirement, but it allows you to have more options for mortgage lenders, especially if you cannot put up the usual 20% down payment. If you have questions about the home buying process or need help figuring out what to do next, don’t hesitate to contact us at Total Lending Concepts.