When buying a new home, knowing what types of insurance you’ll need is a key step of the process. This article will outline what you need to know about private mortgage insurance (or PMI), which could be a major financial consideration if you plan on putting less than 20% down on your new home.
Home Warranty, Homeowners Insurance & Mortgage Insurance – oh, my!
What’s what? As a first-time home buyer, or someone who hasn’t bought a home in a long time, it can be a bit confusing to figure out the difference.
First things first, know the difference between a warranty and an insurance policy. A home warranty covers things like wear and tear on major appliances and systems of the home, whereas homeowners insurance protects you against occurrences like natural disasters and theft. For more information about home warranties, check out this article that goes into more detail on the topic!
Second, homeowners insurance and mortgage insurance aren’t the same thing. The most important thing to know about the difference between the two is this: Homeowners insurance protects you; mortgage insurance protects your lender.
Private mortgage insurance, or PMI, is something that most lenders will require if you are making a down payment of less than 20% on your home. The insurance will be an extra expense to you that protects your lender in case you stop making payments on your mortgage. Lenders require PMI in these scenarios because if you own less than 20% equity in your home, they see you as a riskier borrower who is less invested in the house.
How do I know if I’ll need to pay for mortgage insurance?
In general, if you expect to put less than 20% down, you’re going to need to pay for PMI. However, different loan types have different requirements:
- For FHA loans, you’ll have to pay mortgage insurance up front as well as monthly if your equity in the home is less than 20 percent.
- VA loans do not require mortgage insurance, even with 0% down. This is one of the main advantages of VA loans, so if you’re a veteran or surviving spouse, this is a fantastic option. Check out this article to find out what the qualifications are to get a VA loan!
- USDA loans do not require mortgage insurance.
How much will it cost?
In general, PMI will cost you 0.5% to 1% of the loan amount on a yearly basis. Depending on the price of your home, this can get a bit pricey. For example, on a $250,000 home you could end up paying as much as $2,500/year, which comes out to $208/month!
Depending on your personal financial situation, you might want to consider whether it’s a better decision to wait until you have a larger down payment saved up to purchase your home. Paying an extra few hundred dollars each month may or may not be worth the ability to purchase a home with a low down payment.
However, there is some good news! You can usually cancel your mortgage insurance once your equity in the home hits 20%. Make sure to keep track of when you’ll hit this milestone and contact your lender to discuss your options – they probably won’t be sending a congratulatory postcard! Depending on your lender, you may have to send a formal letter requesting the cancellation, and you may also need to get a formal appraisal of the home done.
A common question is whether or not your PMI payments are tax deductible. The answer is, sadly, no. This used to be the case in certain circumstances, however, the 2017 Tax Cuts and Jobs Act ended this deduction.
Are there any other ways to avoid paying PMI if I’m putting less than 20% down?
It can be possible to avoid paying for mortgage insurance if you get a piggyback mortgage. In this scenario, you actually split up the mortgage by taking out two loans. However, you can encounter risky terms on piggyback mortgages. If you’re interested in this path, here’s an article from Investopedia that details how to combine two mortgages.
Overall, like many aspects of the home buying process, whether or not it’s worth it to buy a home with a small down payment is going to completely depend on your personal situation. Like anything else, make sure to read the fine print and be aware of how much PMI will cost you on a monthly and yearly basis.
Want to find out more about whether or not you’ll want to get a home warranty? We have an entire article on the topic, available here.