PMI, or private mortgage insurance, is designed to protect the lender in the event you default on your loan. It’s also what allows buyers with lower down payments (or even none at all) to purchase a home despite their lack of savings.
For conventional loans, you’ll typically need to pay for PMI unless you can put down 20 percent of the purchase price. Once you’ve paid off at least 20 percent of the loan, you can cancel PMI and stop paying any associated fees.
However, USDA loans don’t have PMI. Instead these specialized loans come with both an upfront and annual forms of mortgage insurance. The good news is the costs of USDA mortgage insurance are significantly lower than on other loan products.
In fact, mortgage insurance costs on FHA and conventional loans can be double or even triple those of USDA mortgages, posing a serious barrier for low-income and cash-strapped buyers.
On USDA loans, mortgage insurance is paid via two fees: an upfront guarantee fee and an annual fee. The guarantee fee is paid only once, up front, when you initially close on your loan.
The annual fee is paid every year until the loan balance drops below 80 percent.
Annual USDA loan fees are lumped into your monthly payment and gradually decrease over time.
USDA mortgages have the lowest guarantee fee of all government-issued loan products.
The USDA upfront guarantee fee, often referred to as the USDA funding fee, is 1 percent of the total financed amount – meaning the total balance of the loan, not the sales price of the property.
Here’s an example of how the USDA guarantee fee is calculated: If you bought a $250,000 home via a USDA loan with no down payment, you would pay a guarantee fee of $2,500 (250,000 x .01 percent). If you decided to pay a $10,000 down payment, that would lower your loan amount to $240,000 and your guarantee fee to $2,400 (240,000 x .01 percent).
In addition to the USDA funding fee, you will also have an annual fee of 0.35 percent of the loan’s balance. Because the balance of the loan goes down significantly every year, the annual fee will gradually decrease until PMI is no longer necessary.
Here’s how you would determine your USDA annual fee:
Loan amount: $250,000
Funding fee: $2,500
Total loan balance: $252,500 (loan amount + funding fee)
Annual fee: $883.75 (0.35 percent x $252,500)
Monthly payment: $73.64 ($883.75 / 12)
USDA loan annual fees are recalculated at the anniversary of the loan’s closing date every year, then spread evenly out across the next 12 months.
Mortgage insurance rates vary by loan product, down payment, credit score and other factors, but rates on USDA mortgage insurance are typically lower than most other loan options on the market.
Generally, rates on FHA and conventional loans range anywhere from 0.5 percent of the loan amount to upwards of 1 percent or more.
On a $250,000 loan, a 1 percent rate would mean $2,500 a year in PMI costs. Compared to the $888.75 in the example above, a USDA loan could potentially save you thousands of dollars in PMI expenses over the course of your loan.
With low mortgage insurance costs, no down payment requirements and less stringent income and credit requirements, USDA loans open the door to homeownership for many who have previously been shut out.To learn more about mortgage insurance on USDA loans and your eligibility, contact a home loan specialist today.