When you buy a new house, there are a lot of things to consider: how are you going to furnish it? Decorate it? Should you buy a walk-behind or riding mower for the yard? Does it need any upgrades or repairs? The list goes on and on.
And then there are the financial considerations: fixed loan or adjustable rate mortgage? 15-, 20-, or 30-year term? What kind of down payment should you make on the property? While not as compelling as the design-related questions – let’s be honest, even most guys will admit they’d rather shop for a new couch than compare home loans – they’re far more important.
Why? Because a wrong step here could leave you feeling the effects for years, even decades; you’ll only regret that ugly eggplant color on your bedroom walls until another $20 gallon of paint comes to your rescue.
Once you select your loan and head toward your closing date, you’ll be hit headlong with a series of fees and various types of insurance policies. In fact, you could be faced with three different insurance policies before all is said and done. And while a trio of policies may sound redundant, each one works in a different way to protect you or your lender.
Taking out a mortgage? Then you won’t be able to avoid title insurance. Although you’ll pay the premiums – typically several hundred or even thousand dollars – you aren’t the real beneficiary of this policy. Who is? The actual title holder: in this case, your lender.
Wait, you’re probably saying, why am I paying the premium if the policy isn’t really for me? Good question. Title insurance protects your lender in case of any issues that may come up regarding your property’s title. Say someone forged a signature on a document during your property’s title transfer; that’s where title insurance comes in. Even if the error – whether intentional or accidental – happened last week, last year, or last century, the wronged party could try to reclaim the property today. Title insurance also protects the title holder against property liens; this includes things like unpaid real estate taxes, legal fees, or homeowner’s association dues.
Title insurance works differently than many insurance policies you’re probably used to. Here are three main differences:
- You pay for the policy in one lump sum, up front. Usually, this is included with your closing costs. You’ll never have to pay another dime for the policy, unless you refinance the property (in which case, you’ll actually pay for a new title insurance policy).
- While the lender is protected, you’re not. A title insurance policy protects the mortgage amount – in other words, the amount of money the lender is in for – but it doesn’t protect your equity in the home.
- This is in many ways a retroactive policy. In fact, your lender’s protection ends on the same day as it begins. What do I mean? Well, the policy doesn’t protect the lender from future title errors; rather, it extends into the past, protecting the lender only against problems leading up to the day the policy begins (the next person to buy your house will have to take out title insurance to protect their lender against issues that may arise during your ownership).
There’s only one way to get out of having title insurance: paying off your loan, in full. If you pay for a piece of property up front without a mortgage, you won’t need title insurance. Likewise, once your home is paid off, the policy expires. Why? Because at that point, you’re the title holder, and the lender no longer has a stake in your property.
Private Mortgage Insurance
Private mortgage insurance, or PMI: it’s the bane of existence for many cash-poor house hunters. PMI is another one of those insurance policies that you pay for in order to protect your lender. Generally speaking, you’ll need to have PMI on your property if you make a down payment of less than 20 percent, although there are still some lenders that will give you a PMI-free loan if you put down 10 percent or more, although they are few and far between. Certain mortgage programs – like the Fannie Mae HomePath program – also offer PMI-free loans if you buy certain properties.
Unlike title insurance, you’ll be paying a monthly premium for your PMI. The exact amount varies depending on three things:
- The amount of your home loan
- The term of your mortgage
- The size of your down payment
The tiered system for PMI for a 30-year fixed loan looks like this:
- Make a down payment of 3-4.99% – PMI of 0.90%
- Make a down payment of 5-9.99% – PMI of 0.78%
- Make a down payment of 10-14.99% – PMI of 0.52%
- Make a down payment of 15-19.99% – PMI of 0.32%
(Note: Different lenders may have different PMI requirements and standards. This is the basic tiered system.)
So, say you put down $10,000 on a $200,000 property – that’s a down payment of an even 5%, putting you in the 0.78% PMI tier. To figure out your annual PMI premiums, you’ll use this formula:
$190,000 (loan amount) x 0.0078 (PMI tier) = $1,482
That’s how much you’ll pay in PMI every year; to get your monthly premiums, simply divide that number by 12. So in this example, you’ll pay $123.50 a month in PMI. You’ll pay this amount every month until your loan-to-value (LTV) mark on your loan reaches 20%. If you bought a new home today under these terms, it would take you until September 2020 to reach the 20% LTV mark of $160,000.
Just as with title insurance, you don’t need to have a homeowner’s insurance policy – unless you’ve taken out a mortgage on your property. Most lenders (I should say all; I’ve never come across a lender that didn’t require homeowner’s insurance) require you to have this policy as long as you’re making payments on the property. Once your mortgage is paid off, you can cancel this policy, although I wouldn’t recommend it.
But other than that, what does homeowner’s insurance have to do with buying a home? Two things. First of all, many lenders factor it into your debt-to-income ratio, which helps determine whether or not you qualify for a loan in the first place. There are places where you can get a loan for bad credit, but the interest rates are likely high. Second, a portion of your new house’s homeowner’s insurance policy must be paid at closing, and is lumped in with your closing costs. Because you must pay for this policy in advance – ie, paying now protects you for the next year – you’ll have to pay for your first year’s premiums before moving in. Although homeowner’s insurance is designed to protect you, it protects the lender as well by protecting their investment – and insuring their property is safe and sound.