Mortgage insurance is a lot like medicine. You know you have to have it but it doesn’t mean you have to like it. When you take medicine you can often choose to take it in a liquid, a pill or a shot. What many consumers don’t know is that mortgage insurance also gives you choices when taking your “medicine”.
Why Mortgage Insurance?
Mortgage insurance, also known as Private Mortgage Insurance or PMI, helps lender’s mitigate risk and exposure when lending to borrower’s who are putting less than 20% down on the purchase or has less than 20% equity for a refinance of the their home. Without Mortgage insurance home buyers would have to save for a significant down payment and wait much longer to purchase a home.
How does it work?
Mortgage Insurance is designed to compensate lenders and or investors for losses due to the default of a mortgage loan. For instance:
- A borrower buying a $150,000 home makes a 10%, or $15,000, down payment.
- The lender then obtains private MI on the borrower’s $135,000 mortgage, reducing its exposure to lossfrom $135,000 to $101,250.
- The private MI covers the top portion of the mortgage – usually the top 25% to 30%. In this case, the MI willabsorb 25%, or $33,750, of any ultimate loss to the lender.
What are your choices?
The cost of mortgage insurance will vary depending upon the loan term, type of loan, credit scores (typically a 680 mid score is required on conventional loans), proportion of total home value that is financed and amount of coverage required for the loan program. However, there are choices you can make as to how you want to pay.
There is no one size fits all solution to mortgage insurance, there are pro’s and con’s to each option. The key is to choose the one that best fits your situation. The problem is that many lenders only offer one option without educating the borrower on the available options or taking the time to evaluate which one fits the individuals needs best.
Monthly Mortgage Insurance – The most common type of mortgage insurance, it is added each month to your principal and interest payment. For instance with a $200,000 loan with a 10% down payment and a 700+ FICO on a 30 year fixed rate loan, the annual mortgage insurance would be approximately .56%. Divided over 12 months which means you will pay an additional $93.33 per month in addition to your monthly payment.
This type of mortgage insurance can be removed typically when your properties value increases (based on a new appraisal) so that your loan is a total of 75% of the value of the home. Also under the Federal Homeowner’s Protection Act MI can be canceled automatically when the loan amount reaches 78% of the original appraised value.
Some homeowners may have some tax deductibility with mortgage insurance. The MI tax deductibility provision passed in 2006 provides for an itemized deduction for the cost of homeowners earning up to $109,000 annually. The original law was extended through the 2010 tax year.
Single Premium – Mortgage Insurance can be paid in a single premium. On the same $200,000 loan with a 10% down payment and 700 FICO and a 30 year fixed rate you can purchase a single premium for approximately 1.45% or $2900. Now this may sound like a large sum for someone who is struggling to put together the 10% down payment. However what borrower’s don’t always think about is their ability to negotiate to have the seller pay expense for them. It is important to discuss this option with your Realtor prior to making an offer. Many times your offer will be slightly higher in order to offset the cost you are asking to have paid by the seller.
Idea for home Sellers – This is also something for home sellers to think about. If you want to have your property stand out in the market offering to pay for the mortgage insurance for a home buyer is a BIG plus. For a $2900 expenditure (using the example) you will be saving the buyer $1116 per year ($93 x12). Assuming it takes 5 years to accumulate enough appreciation to remove the mortgage insurance the buyer would realize as a savings of $5580 for a $2900 expenditure on your part.
Split Premium– This is a newer option that allows for a partial payment upfront and the balance paid monthly. Using the same $200,000 loan you would pay approximately .84% upfront ($1680) and .70% annually or $70 per month. This is a way for the seller to pay a portion and the buyer to finance the remainder monthly.
Lender Paid Mortgage Insurance – Whenever you hear about a 10% down loan with no mortgage insurance you need to be a bit suspicious. Chances are you are being sold Lender Paid Mortgage Insurance. In this instance you agree to accept a higher interest rate (usually about .375% to .50% higher) and the lender pays the mortgage insurance on your behalf.
This is an excellent option for home buyers with incomes that do not qualify for the Mortgage Insurance Tax Deduction. It allows the home buyer to take an expense that is non-tax deductible and convert it into an interest expense which has potential tax deductibility.
The total payment with mortgage insurance and the increased payment with lender paid mortgage insurance are usually very close. The only drawback to lender paid mortgage insurance is the inability to remove it. With the monthly mortgage insurance you are able to decrease your payment after your equity increases.