“Why do i need to save up 20% down payment to purchase a home?”, is normally the beginning question for some who are first time home buyers and at the beginning stages of their research. Well the main reason is to avoid paying PMI (private mortgage insurance) in addition to your mortgage principal and interest payment, as well as getting a better interest rate.
How Does PMI Work
When purchasing a home you have to make the decision as to who much down payment you want to put down on new mortgage loan. If your down payment is going to be less than 20 percent of the appraised value or sale price, your lender will require you to get mortgage insurance, which will be added to your total monthly payment. As a borrower, you pay the premiums, and the lender is considered to be the beneficiary. The private mortgage insurance policy will protect the lender in case you default on your payments.
How is PMI Calculated
Mortgage insurance fees will vary, depending on the type and size of the loan, the down payment amount and the borrower’s credit score. The percentage amount can be around 0.3 percent to 1.15 percent of the original loan amount each year. For the entire year of 2013 mortgage insurance premiums are tax-deductible and it is possible that Congress could extend deductibility longer into the upcoming years.
To help you get an idea of how much will be added to your monthly payment, you can use any mortgage calculator. This will show you an estimated monthly payment which will include, principal, interest, taxes, homeowners insurance and PMI.
So now the next question will be how do I get rid of the mortgage insurance? Well, borrowers can choose to have the PMI removed sooner than later. On conventional loans only, when your loan-to-value ratio hits 80 percent, the lender will no longer require the PMI premiums and it will be discontinued. At closing, Federal law does require lenders to tell the borrower how many years and it will take for them to reach that 80 percent level and cancel PMI. It will be up to the buyer to keep track and notify the lender. If the borrower does not contact the lender at the 80% LTV mark, by law the lenders must automatically cancel PMI when the balance hits 78% of the original value of the home. When that time comes, the homeowner must be current on the loan.
Now please keep in mind that paying down your mortgage faster does not necessarily speed up this process. You can ask the lender to cancel the mortgage insurance but there is not guarantee they will say yes. Paying your loan down is different from simply having 20% equity in your home because its based on the current market value. Also, you are required to wait 2 to 5 years after taking out the loan to make such a request or it may be automatically rejected.
“ Automatic termination at the 78% threshold is not based on the actural payments made, but is based on the date that the loan is first scheduled to reach 78%, according to the initial amortization scheduled,” says Sara Millard, senior vice president and deputy general counsel at the United Guaranty Corporation.
Exceptions to the rule
On FHA loans, these are not governed by the same laws. As of 2013, the FHA mortgage insurance will never be discontinued and will stay on for the life on the loan. The only way to have the PMI removed will be to pay for an appraisal and refinance into a conventional loan. If after the appraisal, it is determined that you do not have 20% equity but have cash to pay down the mortgage, refinancing may still be the better options.