You can buy a home with as little as 3% down, but there is a catch! When you finance your home purchase with less than 20% down, you will be required to carry mortgage insurance. The mortgage insurance protects the lender from financial losses if you default on the loan and fall into foreclosure.
Mortgage insurance is commonly referred to as PMI (Private Mortgage Insurance) or MIP (Mortgage Insurance Premium.) Simply put:
PMI is used for Conventional mortgages. The cost of PMI generally runs about .05% to 1% of the loan amount, and is added to your monthly mortgage payment. There is also single-premium PMI that requires a lump-sum payment at closing, or you can finance it within your mortgage.
PMI can be waived once you reach at least 20% equity in your home, whether through home value appreciation, additional payments to principal, or a combination. You do not need to refinance to waive your PMI. Simply make a request to your lender and they will explain the process. You may be required to obtain a home appraisal to prove an increase in market value.
MIP is used for loans backed by the Federal Housing Administration. (FHA.) FHA loans may contain an upfront premium at closing in addition to a monthly amount. The rate of your premium depends on your loan payment amount and the length of the loan.
As of 2013, FHA loans with less than 10% down require that MIP remains for the life of the loan. If you have more than 10% down, you will be required to carry MIP for 11 years.
To escape the MIP costs on an FHA loan, some homeowners refinance when they achieve a minimum equity amount of 20%. However, this isn’t an attractive strategy when interest rates are rising.
Mortgage insurance can be avoided altogether if you have 20% down when buying your home. There is one important exception: if you are a veteran or service member who is eligible for a VA loan, you are not required to carry mortgage insurance, even if you do not make a down payment.
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