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Mortgage Insurance: The Basics

Mortgage Insurance generally has a negative undertone when I discuss financing with clients.  Most new homebuyers pay mortgage insurance in some form, either monthly, as a single-premium, or as lender-paid.  Unless you are qualifying as a conventional loan with 20% down or are a VA borrower, you will pay mortgage insurance.  But how you pay it can be an advantage, saving you money in both the short term and long term.  If you must pay mortgage insurance, let’s use it to our advantage.

Fun Fact

Conventional loans with a loan-to-value (LTV) less than 80% must pay mortgage insurance and will typically have a slightly lower interest rate than a loan with 80% LTV.  As crazy as that sounds, it makes sense.  Here’s why:

Loans that have mortgage insurance go through a second underwriting process through the mortgage insurance company such as MGIC or National MI.  This is a third-party underwrite.  In addition, the loan itself is insured against potential losses to the bank in the event of a foreclosure or short sale on the home.  The bank purchasing the loan will price the interest rate better than 80% LTV because layers of risk were mitigated and insured.  Think about it, the bank lends on risk/reward.

3 ways to pay PMI with Conventional Financing

Mortgage Insurance, for conventional financing, is priced/scored based on the borrower’s FICO score and LTV or down payment.  The better the FICO score, the better the pricing.  Each option comes with a list of considerations before picking which option is the best.  A later blog post will outline these considerations.

  • Monthly PMI – The most common method for paying mortgage insurance because it’s the cheapest in the short term.  Many borrowers pay the monthly factor and refinance once their home appreciates to having 20% equity.  There is no additional fee added to closing costs to have monthly PMI.
  • Single-Premium PMI – Becoming more common when borrowers have high FICO scores and are putting 10% or more down to buy a home.  This option “buys out” the monthly PMI and is tax deductible through 2020, for now.  Visit the IRS site for additional details.  A borrower can also refinance with single-premium PMI and include the cost in their loan amount if it makes sense.
  • Lender-Paid PMI (LPMI) – With LPMI, the lender pays the single-premium mortgage insurance on behalf of the borrower with a higher interest rate.  The result is no upfront expenses and no monthly PMI.  As some point, the borrower will want to refinance to get a lower rate, provided the equity is at 80% LTV to avoid any PMI.  LPMI requires a thorough review of a borrower’s profile to understand how their payment is impacted. 

FHA vs Conventional

Borrowers should note that monthly mortgage insurance is not permanent on conventional loans like it is for FHA loans with less than 10% down or less than 10% equity.  The Homeowner’s Protection Act of 1998 (HPA) mandates that PMI (mortgage insurance) on conventional financing must drop once the loan amortizes to 78% LTV.  On FHA, you must refinance (or payoff your mortgage) to eliminate the mortgage insurance for any new loans originated today with less than 10% down. 

However, it is possible to request the Mortgage Insurance company to drop your PMI before your loan amortizes to 78% LTV if you have a conventional loan.  If the equity in your home has appreciated to 75% and you’ve held the PMI for 2 years, you can request the Mortgage Insurance company to perform an appraisal to show the value is 75% LTV.  Some of my clients have been successful in this approach.  They can keep their first mortgage terms such as the interest rate and remaining loan term.  A good mortgage advisor will be able to help you forecast expectations and plan reasonably for different considerations.

Summary

Mortgage Insurance enables First-time buyers and seasoned homebuyers to access homeownership without breaking the bank.  The overall cost of PMI is minimal compared to the equity gained over a short period of time.  It allows consumers to keep additional cash, otherwise used for the down payment, in their saving accounts and budget responsibly for homeownership. 

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When is a Good Time to Buy a Home?

The first time the idea of purchasing my first home came to light, it was my future father-in-law that made the suggestion.  This was 2 years before I became a loan officer in 2012.  I was working in retail finance, but had so much debt from school, the idea of homeownership never crossed my mind.  The suggestion from my future father-in-law came up because I needed a place to live.  It also may have been a plot to marry his daughter, my now lovely wife.  But we will move on from there.

Necessity vs Timing

Most of the time, people get the idea of purchasing a home because they have a lease coming due to either renew or move on to a new place.  This creates a necessity for maybe buying a home.  It feels convenient to start looking for a home to buy right away when these scenarios come up:

“I am paying $1700 to rent, my lease is coming due, I’d rather pay this money toward a home”. 

Or, it’s: “I am paying $1700 to rent, my landlord is selling the place, they are requiring me to move.” 

Finally, some scenarios playout like this: “I am paying $1700 to rent, my landlord is raising my rent to $2000, I need my own place”.

Everyone’s example of necessity is different.  I find that most prospective borrowers are not prepared for WHEN this time comes.  It’s never a matter of IF this happens but WHEN this happens. 

Take note, you may not be in the position to buy a home now, but it makes good financial CENTS to start preparing and planning for this later.  You then can take necessity and control it with your timing.  Preparation is the key to anything financial and puts YOU in control of your necessity.  Check out steps to pre-qualify for a home loan

Income, Credit, Assets

Perfect credit nor a six-figure income are necessary to purchase a home.  It’s true that your income, credit and assets determine how much you could pre-qualify for or afford for a mortgage payment.  Here are some general tips for when it’s a good time to buy a home:

  • INCOME – You should have a 2-year work history.  This simply means you should be able to show you have consistently earned some sort of income, generally in the same line of work.  There are many types of income considerations, especially for self-employed or variable income borrowers.  Stable and consistent are what the underwriting guidelines measure.
  • CREDIT – A 740 FICO is not required for qualifying for a mortgage loan, nor is perfect credit.  Government loan programs (FHA, VA, & USDA) have exceptions for certain types of credit from how low the scores can be to when a bankruptcy must be seasoned by.  I’ve had Buyers at 580 & 600 FICOs qualify and purchase a home.  Others had bankruptcies seasoned 2 years or less.
  • ASSETS – Down payments are not as scary as some people imagine and are much lower than people realize.  Veteran borrowers need $0 down (in most cases), FHA buyers need at least 3.5% of the purchase price and Conventional buyers can put either 3% or 5% down as the minimum, depending on their income profile.  See more about down payment sources

Market Influences

Have you heard in the last 10 years, “It’s a great time to buy a home!”?  This phrase has been used so much over the last 10 years that it frankly means nothing anymore.  Yes, it is still a good time to buy a home.  But we must ask ourselves WHY in the new decade.  The last 10 years included the recovery of the housing crisis from the recession of 2008.  Analysts are saying we’ve recovered from 2008 and are now where we should have been (hence why it’s called a recession).  So, what does that mean for the future?

The future of homebuying remains strong for most markets largely due to technology and how business is conducted.  Right now, the southwest is a hot market for new emerging and developing businesses and becoming a safe haven for year-round operations for manufacturing and call center business types.  Property taxes, land, and cost of living are much less in most parts of the Southwest and offer a lifestyle for employees that most of the country cannot compete with including year-round sun, Interstate access for distribution, and close proximity to places like California, Las Vegas, and Mexico.  Basically, housing in the Phoenix Metro area is going to continue to thrive, even in a recession because Arizona is what Governor Doug Ducey calls “open for business”. 

What does this mean for buying a home in our market?  Your property value will continue to appreciate even now.  There is a shortage of housing in Phoenix for homebuyers and renters alike.  As our market attracts more businesses, there is a need for housing all over the valley.  It’s basic supply & demand with housing and it’s expected to continue.  Your home will continue building wealth for your future.

Summary

Buying a home is personal and not always for everyone.  See Beyond the Numbers.  It takes some responsibility to understand the opportunity.  Only you can make that decision.  10 years ago, the decision was easy because home prices were extremely low.  Today, it’s a little more complex only in as much the level of preparation of the prospective buyer.  We are here to help in that preparation.