One of the services that enables borrowers to buy homes without making large down-payments is mortgage insurance (MI.)
While all loans by nature are risky, borrowers who put 20 percent down, or who refinance with 20% equity in their homes, are considered to be good risks. They have "skin in the game" that they don't want to lose and that helps protect the lender, too.
Many first-time and low-income borrowers are good risks, but it would take them too many years to save enough money to buy a home with 20 percent down or more. Many high-income borrowers may have enough cash to put that much down, but they prefer to leverage their credit and use their cash for other purposes.
If you're one of these borrowers, the advantages to MI are many. You can get into a home sooner with a much lower down payment, as little as five percent down in some cases. Your MI is 100% tax deductible and you can tailor your MI payments to suit your income. You can pay monthly, annually, or finance the entire amount into your loan.
Depending on the laws in your state, how well you've handled your payments, and other criteria, you can get your private MI canceled once you've reached 20 percent in equity. It's canceled automatically if the loan to value is paid down to 78 percent based on the original value of the property.
In markets with significant housing appreciation, it's possible to get MI removed from your loan sooner than five years. You can do this by paying more toward your principal each month, or if you can prove that your home has acquired at least 20 percent equity via the marketplace.
There are several ways to get mortgage insurance. MI is available with government-insured loans like FHA for qualifying borrowers and through private mortgage insurance companies such as PMI Group.
A typical mortgage insurance program is a five-year term, which means the insurance is paid in full in five years. This is based on the loan amortization schedule for loans in which most of the monthly payment goes to pay the interest on the loan and to reduce the principal. Once the principal has been reduced to the amount insured by MI, the MI is paid in full and is automatically removed from the loan.
Your lender will tell you what is required to remove MI, such as getting a bank appraisal and showing recent sold comps provided by your real estate professional. But with some types of loans such as FHA loans, which are popular for requiring relatively little money down, borrowers pay MI for the life of the loan with no possibility to cancel the MI.
The alternative to getting a loan with MI is simply pay the bank a higher interest rate, and they pay the MI, but keep in mind that interest rates never go down unless you are able to refinance the loan to a lower rate.
Should you be concerned if you can't afford to buy a home without MI? No. Just think of it as part of the interest rate. Because you have less skin in the game, the lender wants to make sure the loan will be paid in case of default. MI provides that assurance.