Home Mortgage Requirements: Down Payments and PMI

The phrase "20 percent down" is important to mortgage lenders and mortgage applicants. Home mortgage applicants who can pay twenty percent of a home's purchase price upfront don't have to worry about paying for private mortgage insurance (PMI) or the additional cost of an FHA loan. Mortgage lenders, their investors and mortgage insurance companies prefer to see larger down payments, as they believe that the more homeowners have invested in their homes, the less likely they are to default on their home loans.

Higher home prices can make it difficult for home buyers to come up with down payments of 20 percent or more. Mortgage lenders offer alternatives, including FHA mortgages and loans with private mortgage insurance. These allow borrowers to buy houses with down payments ranging from zero percent in the case of VA and Rural Housing loans to 3.5 percent for FHA programs to five percent for Community Homebuyer programs. In addition, Fannie Mae announced in October 2014 that it will be bringing back loans requiring just three percent down.

Private Mortgage Insurance

The conventional home mortgage is not backed by VA, FHA or other government programs. They typically max out at 80 percent of the purchase price, or the home buyer must buy private mortgage insurance (PMI). PMI protects mortgage lenders against losses incurred on failed mortgage loans. When a mortgage goes into default and the property is foreclosed at a loss to the lender, the PMI company reimburses the lender according to the terms of the policy. Mortgage borrowers are required to pay the cost of PMI, but it's for the lender's protection, not the homeowner's. PMI is required with most conventional home loans when applicants have less than a 20 percent stake in their property purchases.

Homeowners may be able to cancel their PMI coverage when their home's loan-to-value ratio (LTV) reaches 80 percent, and lenders are required by law to automatically drop coverage when the loan is paid down to 78 percent of the original home value / purchase price. The loan-to-value ratio can be estimated by dividing a home loan's current principal balance by the home's current value.

FHA Home Mortgages

Saving 20 percent down can be challenging, especially in high-cost metropolitan areas. The Federal Housing Administration (FHA) provides the government's version of private mortgage insurance. Due to recent increases in its charges to mortgage borrowers, FHA loans are not as affordable as they once were. FHA mortgage insurance has two types of premiums. The first is an upfront mortgage insurance premium of 1.75 percent of the mortgage amount. The upfront mortgage insurance is typically added to the loan balance, but it can also be paid at closing.

FHA also charges an annual mortgage insurance premium (MIP) that is divided by 12 and added to monthly mortgage payments. The cost of MIP varies by loan amount and down payment. Unless borrowers put at least ten percent down, they can never cancel this coverage. Even those who take out 90 percent FHA mortgages have to pay mortgage insurance for a minimum of 11 years. The table below shows FHA mortgage insurance premiums as of 2014.

fha insurance

When shopping for a new home or refinancing an existing mortgage, homeowners are encouraged to shop and compare mortgage quotes for conventional and FHA loans, including their mandatory mortgage insurance premiums.

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