Mortgage insurance allows you to buy a house even if you can’t afford a 20% down payment amount while making your situation favorable to the lender by protecting them if you fail to pay.
This can be a great decision in certain circumstances but also a financial nightmare in others.
Determining if it works for your situation is difficult, but this guide aims to help you with that as much as possible.
You can also receive advice tailored to your individual situation if you contact us at Physicians Thrive.
Key Takeaways
- Mortgage insurance allows home purchase with less than a 20% down payment.
- Benefits include lower upfront costs, competitive rates, and temporary coverage.
- Drawbacks are extra monthly costs and protection favoring lenders over borrowers.
- Mortgage insurance suits rising markets but not for stable or falling prices.
Table of Contents
What Is Mortgage Insurance? The Long Answer
Mortgage insurance is the money you pay each month to protect your lender’s interests in case you stop making payments on your home loan.
You’ll need this kind of insurance when you put down less than 20% of your home’s price as a down payment.
For example, if you want to buy a $300,000 house, the 20% down payment would be $60,000.
However, if you currently have only $30,000 saved up and can’t wait long enough to get the 20% (which will mostly increase by the time you save up), mortgage insurance can help.
In this scenario, with mortgage insurance, you can put down your $30,000 as a down payment for your house, which is 10% of the house’s price, bringing your loan to $270,000.
The cost of mortgage insurance can vary, but it’s often between 0.5% to 1.5% of your loan amount per year.
Circling back to our example and assuming your mortgage insurance rate is 1%, you’d pay $2,700 per year (which winds down to $225 per month) on top of your regular mortgage payment.
This insurance gives your lender peace of mind about lending you more money since they know they’ll get paid back even if you can’t make your payments.
Advantages of Mortgage Insurance
Here’s why private mortgage insurance (PMI) can be a great idea:
Lower Down Payment Requirements
PMI makes it possible to buy a home without saving up a huge down payment.
Instead of putting down 20% on a conventional loan, you can get a Federal Housing Administration (FHA) loan or other mortgage with as little as 3% down. (In our example, that’s only a $9,000 down payment).
The mortgage lender will require mortgage insurance premiums in exchange for this lower upfront cost, but the tradeoff helps you buy a home sooner than expected.
Access to Competitive Interest Rates
When mortgage insurance protects the lender, they’ll be more consistent about offering you better loan terms.
Even with the smaller down payment, you can often qualify for interest rates similar to those given to buyers with 20% down.
On a conventional loan, this could mean paying 6% interest instead of 7% or potentially higher.
This may not seem like much, but over a 30-year mortgage, this interest rate difference can save you tens of thousands of dollars.
Temporary Coverage
You won’t need to pay mortgage insurance forever. Once you’ve built up 20% of equity in your home through your monthly payments or home value increase, you can often cancel your PMI.
For example, if you start with a 5% down payment, you might reach this 20% mark in 5–7 years of regular payments.
Once you cancel, your monthly mortgage payments will drop significantly, which gives you more financial flexibility.
We’re not saying that you have to pay your home off early (even though it is beneficial to try if you can) but less PMI insurance means more toward equity in your home.
Disadvantages of Mortgage Insurance
Let’s explain some of the drawbacks of mortgage insurance in detail.
Additional Monthly Costs
The small down payment comes at a cost.
If you put a 5% down payment for our $300,000 example house, you’re expected to pay an additional $200–$300 per month as mortgage insurance premiums.
When these add up, they turn into $2,400–$3600 a year. For a 30-year mortgage, that’s $72,000–108,000, which is quite the financial hit.
Plus, remember how we said that you can “often” cancel the insurance after you own 20% of the house?
This isn’t applicable if you get FHA loans after 2013.
If your down payment was less than 10% of the house, the FHA mortgage insurance premium for the life of the loan.
If your down payment was at least 10%, you can cancel the insurance after 11 years.
Protection for Lenders, Not Borrowers
Even though you pay for mortgage insurance, it only protects your mortgage lender if you stop making payments.
The insurance company will pay the lender if you default, but you’ll still lose your home and damage your credit.
In other words, you could be paying hundreds of dollars every month for insurance that gives you no direct protection.
Complex Cancellation Process
Getting rid of private mortgage insurance isn’t always simple, even after you’ve built up 20% equity in your home.
Many lenders require you to formally request PMI cancellation in writing. They may even ask for a new home appraisal at your expense to prove your home’s value hasn’t dropped.
You may also run into mortgage lenders who have strict rules about how long you must keep mortgage insurance, regardless of the equity you build over time.
This process can take months and costs a lot in appraisal fees, forcing you to pay mortgage insurance longer than necessary.
Should You Apply for Mortgage Insurance?
The best answer is that mortgage insurance is “situational.” It can be suitable for some people but not others. It can also be suitable for you in one state but not ideal in another.
When to Go for Mortgage Insurance
Mortgage insurance might be a good choice if you can afford the monthly payments but struggle to save a large down payment.
For example, if you live in an area with rising home prices, waiting for years to save 20% could mean paying much more for the same house.
If home prices rise 5% a year (just as an example), our $300,000 home will cost an extra $15,000 from waiting for just one year.
Mortgage insurance also makes sense if you want to keep some savings for emergencies instead of putting everything into your down payment.
If you have $60,000 saved up, using only $30,000 for a down payment and paying MPI lets you keep $30,000 for unexpected expenses or home repairs.
When to Avoid Mortgage Insurance
If you can comfortably save 20% for a down payment without depleting your emergency fund, avoiding MI is a better option.
You might also want to wait if housing prices in your area are stable or dropping.
In this case, taking time to save a larger down payment won’t mean paying more for your home later.
Lastly, you need to consider the credit score. If your score is low, the mortgage insurance premium will be higher.
It might make more sense to spend some time improving your credit score before buying a home.
Closing Words
Mortgage insurance can be a great deal for some people but a costly financial choice for others.
As a physician, your situation can be a bit more complicated, as you probably already have student loans to pay for.
Your specialty and level of career advancement will also impact your decision, which is why you need someone who can put themselves in your shoes.
If you collaborate with Physicians Thrive, you work with other doctors who have gone through the same issues as you.
Contact us today for a free quote; let us know your situation, and we’ll tailor a plan to help you get your dream house while succeeding financially as a physician.
