If you get a mortgage with a down payment that is less than twenty percent, you will most likely be required to carry private mortgage insurance (PMI) on your loan. Private mortgage insurance is protection for your lender in the event you should default on the loan. So the insurance is not for you, it is for the lender. However, you are the one who has to pay for it. This is because a lower down payment puts the lender more at risk if you default. With a high down payment, there will be equity built up in the property. In the case of a default on a mortgage loan that has private mortgage insurance, the insurance makes the mortgage payments, but it does not prevent you from losing your home in foreclosure.
Private mortgage insurance is usually .5% to 1% of the amount of the mortgage. On a $200,000 mortgage, the private mortgage insurance would cost $1,000 to $2,000 a year. This adds quite a bit to the cost of the mortgage and monthly payments.
There is an option for borrowers who cannot afford a large down payment called a piggyback loan. These loans are basically second mortgages that can be used to help a borrow avoid having to pay for private mortgage insurance. As an example, if the borrower can only afford a 10% down payment on a $200,000 mortgage, the down payment would be $20,000. The borrower would then take out a piggyback loan for the remaining $20,000 in order to come up with the 20% down payment, and thus avoid having to pay for private mortgage insurance.
Since private mortgage insurance does not contribute towards paying down a mortgage and is not considered interest, it can be more advantageous to take out a second loan instead of paying for private mortgage insurance. The other main option for avoiding private mortgage insurance is to take out a smaller mortgage where you can afford a 20% down payment.
On loans that do require private mortgage insurance, the insurance must be carried until at least 20% of the mortgage principle has been paid. Once that obligation has been fulfilled the borrower can request that the private mortgage insurance be discontinued. Another option for getting rid of private mortgage insurance is to refinance the mortgage loan. However, the disadvantage of refinancing is there will be closing costs associated with taking out a new loan.