What is Mortgage Insurance?
I want to buy a house and I have enough money to make a 5% down payment on places in my price range. My agent said that would be just fine and I should have no trouble getting approved. But now the lender I’m going through to get pre-approval tells me I’ll have to pay something called mortgage insurance if I don’t make a 20% down payment. What is that? Is it the same as homeowners insurance or is it extra?
I’m surprised your real estate agent didn’t warn you about private mortgage insurance. First let’s clear up what it is. Private Mortgage Insurance, commonly referred to as PMI is insurance that you pay each month to protect the lender against the risk that you might default on the loan. The reason why the lender wants to be protected is because you’re putting down only 5 percent.
In the past, 20 percent was the expected down payment if you applied for a mortgage. However, new lending optionsand increased financing through the FHA have created a new lending environment where you don’t necessarily need 20 percent to qualify. At the same time, if you provide less than 20 percent, the lender will apply PMI.
Since you’re only putting down 5 percent, lenders see you as at least a slight lending risk. Particularly following the real estate market collapse, lenders are extremely strict when it comes to protecting themselves against potential default. PMI helps them do just that.
I’d really recommend that you look into housing counselling. You can take courses and find recommendations for first-time homebuyers that can bring you up-to-speed on the buying process so you’re not relying on your agent to tell you everything you need to know.
In the meantime, here are some basics to help you get started:
- If you make less than a 20 percent down payment, you may be applying for an FHA loan. These allow down payments as low as 3 percent.
- PMI generally costs between 0.5 to 1 percent of the entire amount of the loan on a yearly basis. On a $100,000 loan this calculates to $1,000 per year or about $84 every month.
- Your PMI may be tax deductible – ask your lender or a tax advisor to see if you can take advantage of this.
Again, I think the best thing in your situation is to get educated first. Relying on your agent can be really iffy, so it would be better to take something like a first-time homebuyer workshop so you know what’s going on and don’t have to depend on an agent to tell you everything.
I wish you the best and if you need more assistance, don’t hesitate to call us at 1-844-402-3073.
Jeffrey Schwartz is the Executive Director of Consolidated Credit Counseling Services of Canada and President of the Credit Association of Greater Toronto (CAGT).