There are various ways lenders protect themselves from borrowers who do not repay their debts, otherwise known as defaulting on a loan.
One of the ways that lenders protect themselves is by requiring mortgage insurance. Mortgage Insurance is also commonly referred to as Private Mortgage Insurance or PMI. If you make a down payment of less that 20 percent, you will be required to pay for mortgage insurance. Saving enough money for a down payment of 20 percent on a house can take some borrowers' years to accomplish. For a $200,000 home, that is $40,000! So instead of requiring a down payment of 20 percent in order for a home buyer to get a mortgage, some lenders will establish a minimum down payment and then require mortgage insurance. The cost of mortgage insurance is usually added into your monthly mortgage payments, but you may have the option of paying it upfront at the loan closing.
Paying for mortgage insurance probably won't break the bank, but it is still an added cost that could be spent, saved or invested elsewhere. Mortgage insurance will probably require an initial premium payment of 1.0 percent to 5.0 percent of your mortgage amount and may also require an additional monthly fee depending on your loan's structure. Luckily, once you have reached 20 percent equity or when your loan-to-value ratio reaches 80, you can cancel your mortgage insurance and, in turn, probably lower your monthly payments.
If you don't have a 20 percent for a down payment, but you still wish to avoid paying mortgage insurance, you might want to look into an 80-10-10 plan. This plan allows you to make a down payment of 10 percent, and then get two separate mortgages for the other 80 and 10 percents. Usually the smaller amount will have a higher interest and the 80 percent mortgage will have a standard interest rate. This can be a good option if you don't have 20 percent for a down payment, but be sure to crunch the numbers to see if an 80-10-10 plan saves you more money than actually paying for mortgage insurance.
