Mortgage costs include the down payment that home buyers must make on the loan immediately (often 10 to 20 percent) as well as application and processing fees; mortgage payments are the monthly amounts home buyers must pay out for the loan's principal and interest. These two components of a mortgage, however, are only part of the costs that some borrowers must consider, including private mortgage insurance premiums.
Private Mortgage Insurance
Private mortgage insurance covers the existing amount of the home loan. Essentially, this policy makes the mortgage payments for a borrower if he cannot afford to make the payments himself. This keeps the home out of foreclosure and ensures the lender will still receive revenue from the loan. Private mortgage insurance premiums are the separate payments borrowers must make for this insurance.
The obvious advantage of mortgage insurance is that it lowers the risk of the loan for the lender. In return, borrowers are given the chance to take out a mortgage with a lower down payment than they would otherwise be able to afford. Government-backed loans from the Federal Housing Administration (FHA) require this type of insurance but offer loans with only 3 percent required down payments. The debt ratios that FHA loans require, such as a 29 percent mortgage expense to effective income ratio, may be lower than private lenders require.
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Private mortgage insurance premiums differ based on the type of mortgage insurance. Some mortgage insurance options require a 1.5 percent upfront charge for the mortgage insurance premium. Others add in this 1.5 percent of the loan amount but combine it with all other total loan payments or allow payment through an escrow account created when the home is purchased. The 1.5 percentage requirement is common for FHA loans but not guaranteed. There are different private mortgage insurance rates between different loans and lenders, so you must examine your particular loan options to determine your particular rates.
While private mortgage insurance allows borrowers to get a larger loan, this loan may not be the best plan in the long run. Borrowers should always budget for a loan they can afford to pay. Mortgage premiums add an extra expense onto the loan that borrowers may struggle to pay. One possible alternative is to pay the PMI for the first year or two then refinance to a home loan with a larger down payment to lose the premium cost. If borrowers stay with the same loan, the insurance payments do not need to last forever. Homeowners can cancel private mortgage insurance once their remaining loan amount equals or falls below 80 percent of the value of the property. This can occur when borrowers pay off enough of the mortgage or when the value of the house grows enough to reach the 80 percent mark.