by Michael Licamele
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who have purchased a home recently with a down payment of less
than 20% of the purchase price have most likely been required
to obtain mortgage insurance. For most home buyers, the entire
concept of mortgage insurance is both confusing and expensive.
Armed with knowledge of the mortgage insurance system, however,
consumers can use mortgage insurance to their benefit and save
money in the long run.
Mortgage insurance (also known as private mortgage insurance,
PMI or MI) protects lenders against a loss if a borrower defaults.
In the past, mortgage lenders were not permitted to make home
loans without the borrower providing at least a 20% down payment.
The risk was perceived as too great in case the borrower defaulted.
As demonstrated in the 1980's, even 20% equity in a property
can disappear quickly during market downturns.
With the introduction of mortgage insurance, mortgage lenders
were permitted by federal agencies to make loans as high as 97%
of the value of a property. The mortgage insurance company protects
the lender against some but not all of the loss in the event
of a default.
It is important to note what mortgage insurance is not. Many
people mistake private mortgage insurance for mortgage credit
life insurance. Mortgage credit life insurance is a term life
insurance policy that will pay off a borrower's mortgage payment
in the event of the borrower's death. Private mortgage insurance
has nothing to do with this type of coverage. Many home buyers
consider mortgage insurance a hindrance to home ownership. In
fact, the reverse is true. Without mortgage insurance, most lenders
would simply require higher down payments of 20% or more. Since
saving for a down payment represents one of the largest obstacles
to buying a home, mortgage insurance plays an important role
in the home buying process.
Mortgage insurance costs vary with the percentage of down payment,
the loan amount, and the type of loan selected. Lower down payments
and higher loan amounts increase the cost of premiums. In addition,
adjustable rate loan products will result in higher premiums
than fixed rate mortgage loans. While the factors cited above
affect mortgage insurance costs for a borrower, there is little
variation in costs from insurance company to insurance company.
Pricing among competitors is nearly identical.
Mortgage insurance rates are
also higher the worse your credit score. If your minimum credit
score is 680 or higher, then you will get the best rates available.
Mortgage insurance (except through the FHA program) is not available
as of March 2009 to borrowers with credit scores below 580. Borrowers
with credit scores below 580 may be able to obtain an FHA loan.
While mortgage insurance companies differ little in cost, they
do vary widely in terms of their willingness to approve a low
down payment loan. All loans that require mortgage insurance
must be approved by the mortgage lender and the mortgage insurance
company. Home buyers who are rejected for a mortgage loan by
a lender that blames a mortgage insurance underwriter should
ask that lender to submit the loan to other mortgage insurance
One major change in the mortgage insurance industry over the
last several years has been the introduction of monthly mortgage
insurance premiums. Five years ago, a borrower requiring mortgage
insurance was required to prepay the entire year's premium for
mortgage insurance at closing. A policy that cost $60 per month
would mean that closing costs would rise by $60 times 12 months,
or $720. Today, mortgage insurance companies all offer monthly
premiums that essentially finance the up-front charge over time.
That same $60 payment, for example, would today be about $63
per month but $720 would be saved at closing.
Once borrowers use a mortgage insurance program to purchase a
home, their first reaction is usually to try to determine how
long before they can cancel the coverage and stop the monthly
mortgage insurance payment. Most mortgage insurance policies
require that the coverage remain in effect on the loan for a
minimum of two years. After that period, the borrower can request
cancellation of the policy as soon as the equity in the property
is 20% of the value or greater. The increase in equity can be
created by paying down the mortgage loan balance, improving the
property, or through improved market values. In any case, borrowers
must pay for an appraisal that must be submitted to the mortgage
servicing department. Most states now require that mortgage lenders
cancel a mortgage insurance policy once their is 20% equity in
a borrower's property.
The burden to initiate the cancellation of coverage is on the
borrower. Sometimes, despite state regulations, lenders will
refuse to cancel coverage. They can dispute the quality of the
appraisal and delay cancellation, for example. As a last resort,
borrowers can always refinance with another lender when they
are sure that they have sufficient equity in the property. As
an alternative to mortgage insurance, some lenders now offer
low down payment loans with no mortgage insurance. These loans
come with higher interest rates that essentially include the
cost of the mortgage insurance premium in the mortgage interest
payment. The benefit to this option is that usually the slightly
higher rate has a payment that is less than the lower rate with
mortgage insurance. The drawback to these programs is that, unlike
mortgage insurance, the higher interest rate can never be canceled.
Mortgage insurance is now a tax deductible expense, so there
is less of a tax issue when selecting between these options
As always, borrowers should carefully weigh their mortgage insurance
options and programs with a mortgage professional when buying
a home with a low down payment.
Michael Licamele is the Editor of MortgageAlmanac.com
and President of Residential Finance