Mortgage Insurance: What Is The 80/20 Rule?

You will encounter many expenses when purchasing a home. One of these expenses is mortgage insurance. As you look at homes for sale in Estes Park, you should be aware of mortgage insurance and try to avoid this expense.

What is mortgage insurance?

When you finance the purchase of a home, the lender will require you to pay for mortgage insurance if the down payment is less than 20%. The primary reason for mortgage insurance is to offset the risk to the lender and cover the financial loss if the loan defaults. Therefore, you can avoid paying mortgage insurance when you make a down payment of at least 20% of the purchase price.

What is the 80/20 rule?

Mortgage lenders look at several risk factors when assessing a loan application. One of these risk factors is the Loan-to-Value (LTV) ratio. The lender calculates the LTV by dividing your down payment by the value of the home you want to buy. A high LTV means less risk to the lender, whereas a low LTV means more risk.

The 80/20 rule is the minimum LTV ratio you need to avoid paying mortgage insurance. For example, if the value of the home you want to purchase is $500,000, you will need to make a minimum 20% down payment of $100,000. This down payment will set the loan amount at $400,000, or 80% of the home’s value. A higher down payment means less risk to the lender and a smaller loan amount you will have to pay back.

Why do lenders require mortgage insurance on some loans?

A lender is taking a risk when they provide you with a mortgage, and they do not want to take a loss if you are unable to pay back the mortgage. Mortgage insurance is a way for the lender to get their money back if you cannot make the mortgage payments and lose the house. Mortgage insurance only benefits the lender even though you are responsible for making the payments. Also, mortgage insurance is not homeowner’s insurance. Homeowner’s insurance is for your benefit and provides financial coverage if your home is damaged or destroyed.

Do all mortgages require mortgage insurance?

Mortgage insurance requirements vary based on your loan type and your down payment. Here are some general guidelines on how mortgage insurance works with different types of mortgages:

• Conventional – You can have a down payment of as little as 3%; therefore, you will need mortgage insurance. You can cancel the mortgage insurance once you have at least 20% equity in your home.
• FHA – Most FHA mortgages require mortgage insurance regardless of the down payment amount.
• VA and USDA – These mortgage programs do not require a down payment or mortgage insurance but have a funding fee.

As you look at homes for sale in Estes Park, try to have a down payment of at least 20% to avoid paying the extra expense of mortgage insurance.