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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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