Factors to Consider When Purchasing Mortgage Insurance
The amount of your down payment often determines whether you will be required to purchase mortgage insurance. A typical down payment on a home is twenty percent of the home’s value; if you are able to pay that amount when you close on your property, it will not be required.
If you cannot afford a twenty percent down payment, purchasing insurance can enable you to secure a mortgage with a lower down payment. It protects the lender in case the borrower defaults on a loan, making lending institutions more likely to grant mortgages to borrowers with down payments less than twenty percent.
For example, if you purchase a home and pay a down payment of ten percent of the home’s value, your lender may require you to purchase this type of insurance. Usually, you can terminate the insurance once you have paid off twenty percent of your home’s value through monthly mortgage payments and the down payment. This is an incentive to pay down your mortgage quickly, especially in the first few months or years that you are living in your new home. The sooner you have paid at least twenty percent of your property’s value, the sooner you can cancel the insurance and save money.
The larger your down payment, the less insurance you will be required to purchase. For example, if you pay a down payment of fifteen percent of your property’s value, you will likely reach a twenty percent investment in your property sooner than if you had paid a down payment of only ten percent. You will be able to terminate your insurance sooner and will have purchased less overall than if you had made a smaller down payment. A larger down payment also signifies to lenders that you are financially able to make your mortgage payments on time, so your lender will require less insurance than would be required with a smaller down payment.
When budgeting for your down payment, remember that to account for others costs required at closing, such as homeowner’s insurance, finance charges, and the loan origination fee.
The type of mortgage loan you get can affect the amount you spend on insurance. Many mortgages have a fixed interest rate and are designed to be paid off within a specified period of time. Usually, these mortgages last for thirty years, but some may last for a fifteen-, twenty-, or forty-year period. If you have single premium or split premium mortgage insurance, the cost of the insurance is included in your loan, which means you will pay interest on it. If you have a thirty-year mortgage and do not make advanced payments, you will be paying thirty years’ interest. The interest alone can add up to more than the initial cost of the insurance. With a fifteen- or twenty-year mortgage, you will pay less interest on single premium or split premium.
Mortgages with a duration of only fifteen or twenty years will require higher monthly payments but will also allow you to gain equity in the home more quickly. When equity is equal to at least twenty percent of your home’s value, the insurance can usually be terminated. This means that with a fifteen- or twenty-year mortgage, you will spend less overall than with a thirty-year mortgage because you will be able to discontinue your mortgage insurance sooner.
Another common type of mortgage is an adjustable-rate mortgage (ARM). With an ARM, your interest rate will change over the course of the loan. An ARM will have a cap on the percent your interest rate can rise or fall each year and over the course the mortgage. ARMs are usually available in the same time spans as fixed-rate mortgages, so you will likely find options that last fifteen, twenty, thirty, or forty years. Similar to interest on a fixed-rate mortgage, interest on an ARM can affect how much you spend on single or split premium mortgage insurance that is financed in your loan. ARMs often have low interest rates the first few years and then rise. When calculating how much interest you might owe, take into account the possibility that the interest rates on your ARM could increase about two percent per year for the first few years of your mortgage.
When assessing whether you qualify for a mortgage, a lender will take into account your current income as well as your estimated future income. Based on this information, known as your qualifying ratio, the lender will determine the amount you will reasonably be expected to pay each month. Factors influencing your qualifying ratio include your mortgage payment, homeowner’s insurance, property taxes, and the monthly cost of the insurance, if it is required. Housing is generally considered affordable when the cost is around thirty percent of your monthly gross (i.e., before taxes) income.
Just as a mortgage’s affordability is determined by your income, your ability to afford certain types of insurance is also determined by income. Single premium and split premium types of insurance cost less per month than level annual premium or monthly premium. If the cost of your mortgage payments, property taxes, homeowner’s insurance, and other miscellaneous housing costs are close to thirty percent of your monthly income, your lender may recommend single or split premium types of insurance over the other options. Since single and split premium mortgage insurance is rolled into your loan, you will have to pay interest on your insurance. In this sense, even though your monthly costs will be lower, you will end up spending more overall on insurance. Being able to afford a slightly higher payment per month for level annual or monthly insurance can save you money in the long run.
Your income can also affect the type of mortgage that your lender recommends. If your monthly income is higher, you may be able to secure a fifteen- or twenty-year mortgage as opposed to a thirty- or forty-year loan. By making higher monthly mortgage payments, you will gain equity in your home faster and be able to cancel your insurance sooner. The earlier you can terminate your insurance, the less you will pay out.
If you are concerned that a low income will require you to spend excessive money, you may want to research affordable housing programs. The government and private organizations sponsor many programs designed to help those with lower incomes purchase homes more affordably.
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