For homebuyers paying less than 20% down on their home purchase, mortgage insurance is a necessary evil. In many ways this insurance is beneficial because it allows homebuyers to purchase a mortgage with less than 20% down. This insurance protects the lender if the borrower defaults on the mortgage loan buy guaranteeing the lender will receive the amount of the loan that is in default. There are two types mortgage insurance, government loan mortgage insurance (MI) and conventional loan private mortgage insurance (PMI).
Your monthly rate for PMI insurance is based on your credit worthiness just as your mortgage interest rate. The lower your credit score, the higher your PMI payment. The good news for homebuyers is that once your loan to value ratio drops to 80% you are able to cancel the insurance which results in a lower monthly mortgage payment. To calculate the loan to value ratio (LTV), simply divide your mortgage balance by the market value of your home.
Although according to the Homeowner’s Protection Act, your PMI should automatically cancel when the LTV is 78% or less, the borrower will need to request cancellation when the LTV is at 80%. You, as a borrower, should assume the responsibility for requesting this insurance cancellation by sending a written request to the lender once you have proof that your LTV is 80% or lower. If the lender does not respond in a timely manner, re-send your request (always by certified mail), and if the lender does not approve your request,
you may bring an action against them in court.
Most lenders will have specific guidelines about cancellation requests in the PMI policy, so be sure and review the document before attempting the cancellation.
For borrowers with FHA loans the rules are different. Originally the PMI on FHA loans had to be carried for the life of the loan but then the Federal Housing Administration changed that requirement in 2000 since their Mutual Mortgage Insurance Fund had completed a financial turnaround. With this announcement the FHA began allowing borrowers who achieved a 78% LTV to cancel the PMI just like on conventional
Unfortunately in June of 2013, the HUD began instructing lenders that the automatic cancellation of PMI premiums would cease and that any mortgage that was at 90% LTV or greater at origination (most FHA
loans) would be required to maintain the PMI for the life of the loan. For loans that were originated with an LTV less than 90%, the PMI must be maintained for at least 11 years.
Knowing that PMI will be required if the down payment is less than 20%, the borrower should take the cost into consideration when contemplating the home purchase. For example, the cost of the PMI will amount to approximately $45 per month per $100,000 borrowed which translates to an additional $90 per month for a $200,000 mortgage. Since the PMI insurance premiums will be paid over several years of the mortgage, this amount can add to thousands of additional dollars to the loan.
A borrower can avoid paying for PMI by taking out a second loan for the additional amount needed for the down payment. For example, the borrower may elect to pay a cash down payment of 10% and then taking a second for 10% which creates an 80/10/10 loan. The costs of the 1st and 2nd should be considered against the cost of the PMI to determine whether this would be financially beneficial or not. In many cases the PMI is more beneficial to the borrower than detrimental and usually only paid for about two years.
Renter households have been on the rise and home-ownership has fallen among young people since the housing crisis. A new study from Fannie Mae's National Housing Survey states that younger renters would rather own a home than rent for both financial and personal lifestyle reasons. The reason many younger people are renting is not by choice, according to the data. Potential first-time home-buyers have to deal with extremely high credit standards that in many cases can not be met. More here
As you may have heard, the mortgage industry is undergoing major changes in the requirements it sets for buying or refinancing a home. One of these changes is a homebuyer’s diminished ability to avoid paying Private Mortgage Insurance.
Not to worry, there is a silver lining! But first, let’s review the basics of mortgage insurance.
Mortgage insurance is known by two aliases. The first is Private Mortgage Insurance or PMI, which is typically connected with—but not limited to—mortgages secured by Fannie Mae (FNMA) and Freddie Mac (FHLMC). The second is Mortgage Insurance or MI, which is connected with mortgages that are secured by the Federal Housing
Administration (FHA). For the purpose of this article, my references will be inline with
So, what is the purpose of Private Mortgage Insurance?
Simply put, if you are buying or refinancing a home but contribute less than a 20 percent down payment for a purchase or don’t preserve a minimum of 20 percent equity in the home for a refinance, the lender
requires Private Mortgage Insurance. By ensuring that your home's balance will be paid, this policy protects the lender's money in the event that you default on the mortgage. In other words, if the lender is forced to foreclose on the home, the only way it can recover the remaining mortgage balance is to sell the house.
With a home that has less than 20 percent equity, the likelihood or risk of taking a loss is much greater.
Rewind back to the early 2000s. As lending requirements eased, a qualified homebuyer seeking mortgage financing could buy a home with no money down and was not required to pay PMI. This was made possible
by securing a primary mortgage equal to 80 percent of the home price and then combining that with secondary financing of 20 percent. So, for a $400,000 home price, you could avoid paying PMI by financing only $320,000 on a first mortgage while securing a second mortgage for the remaining $80,000. In theory, this worked for both the first and second mortgage lenders.
Since the first mortgage company is legally paid first upon the sale of the home, its risk or exposure was limited to a comfortable 80 percent. The second mortgage lender, willing to take more risk for a higher rate of interest, was hedging its bets on timely mortgage payments in the rising equity market.
Well, I guess you could say that these bets failed to pay off. And thus, these options have virtually disappeared. In fact, the only option for financing a home with less than a 10 percent down payment for a purchase or 10 percent preserved equity for a refinance is a mortgage that requires Private Mortgage Insurance. Whether you pay the premium annually or monthly, or the lender offers a higher interest rate to effectively pay the premium on your behalf, this is the new frontier for the mortgage industry.
So, I’m sure you’re asking , “How in the world could Private Mortgage Insurance benefit me, or anyone for that matter?”
Although the cost may seem substantial, PMI continues to offer more buyers—especially the next generation of home owners—access to home ownership by allowing down payments as low as 5 percent and even as low as 3.5 percent for a mortgage secured by FHA. The alternative would be a return to the dark ages of banking, where a 20 percent down payment was the requirement. Just imagine the effect this would have on home values.
Although the price of Private Mortgage Insurance can vary based on your individual qualifications, the typical cost is roughly one percent of the mortgage amount per year, or $1,000 a year for every $100,000. So, for a
$300,000 loan, you can expect to pay about $3,000 a year in private mortgage insurance.
And here’s the silver lining. This is a small price to pay for otday’s historically low interest rates, especially when you consider the alternatives, namely waiting for the return of equity and/or saving for a heftier down payment. For many families, that could take a long time, and potentially put them at risk of higher future interest rates, which could end up costing them significantly more.