HomeSaving on Mortgage Insurance
by Kirk Hagert
Any consumer putting less than 20% down to buy a home must take the timeto learn about private mortgage insurance. While most Americans have a uniquelove-hate relationship with insurance, few understand mortgage insurance.Actually, many people in the mortgage and real estate industry are in thedark when it comes to mortgage insurance (MI, also known as PMI).
MI is required on most loans exceeding an 80% loan to value (i.e. withless than a 20% down payment). It protects a lender against borrower default.Although the borrower pays the cost of the insurance, a claim would be paidto the lender if the borrower stopped making mortgage payments. MI is notto be confused with mortgage life insurance, which pays a beneficiary inthe event of a borrower's death.
Generally, the investor or secondary market agency that ends up witha mortgage loan (such as Fannie Mae and Freddie Mac) will require MI. Ithas long been known that the incidence of borrower defaults increases asthe loan-to-value (LTV) increases. The less money a borrower has investedin a home, the more likely he or she is to walk away from that obligationin times of financial distress. There are a number of other factors thatdirectly influence or determine a borrower's ability and willingness torepay an obligation, including the collateral (or integrity of the homeitself), the type of mortgage loan (e.g. fixed or adjustable), and mostimportantly, credit history or a lack thereof. Many other factors enterinto the final underwriting decision.
One fact is certain: without mortgage insurance, the dream of home ownershipwould fail to materialize for many Americans. Lenders would simply not bewilling to lend more than 80% of the value of a home because of the risksinvolved. The very existence of mortgage insurance allows people with littlecash to realize the American dream. There are only a few ways for borrowersto avoid mortgage insurance. The first way is to save up, inherit, win orreceive as a gift the 20% down payment. Alternatively, buying a lower pricedhome is an option. Otherwise, some type of mortgage insurance coverage willbe required.
Mortgage Insurance Options
The cost of MI coverage is determined by LTV and the type of loan. Equallyimportant, there are actually several different payment options available.More than 80% of all MI policies issued today fall under the "monthlypremium" category. Under this option, the monthly cost for a $100,000loan with 10% down would be about $43 per month. This premium plan has onlybeen available for three years, but it is immensely popular because it requireslittle or no money up front. In the past, a borrower needed a sizable chunkof cash at the closing to pay for the MI. Monthly premium MI is ideal forthe borrower with very limited cash. Because of the way down payment amountsaffect the cost of premiums, any loan-to-value over 90% is an excellentcandidate for this option. However, just because it is popular does notmean it is the best alternative for everyone.
"Standard annual" premium options require a sum of money upfront at closing. The same $100,000 fixed rate loan with 10% down wouldrequire $600 at closing. While the monthly cost is the same for the firstyear, the annual renewal premium in the second year could drop to as lowas $28 per month in this example. Generally, with loans at or below 90%of the value of a home, the standard annual policy is the better optionif a borrower can afford additional payment due up front and also expectsto keep the mortgage for at least three years.
"Single premium" mortgage insurance is a one-time lump sumpaid for MI at the closing. At 90% LTV or below, the premium may be financedinto the loan. Financing the one-time premium yields two positive results.It lowers the monthly cost of the insurance and provides a tax deductionof additional interest expense for borrowers who itemize tax deductions.However, the MI stays with the loan until it is paid off because it hasbecome part of the loan. Also, only borrowers in the higher tax bracketswill receive a worthwhile tax benefit. These single premium policies arebest used as seller concessions. The seller can offer a percentage (3% forexample) that will cover a non-refundable premium for the borrower, whowill then never have to make an MI payment.
Another somewhat popular product is "lender-paid mortgage insurance,"which is sometimes referred to as a "no-MI" option. The premiumis simply added to the interest rate, making the separate payment invisibleand creating a potential tax advantage similar to a financed single-premiumplan. Again, as with single-premium, the MI is with the loan until it ispaid off and the tax benefit is not as significant for lower income borrowers.
Finally, for the borrower who needs to qualify using the FHA mortgageprograms, MI is usually built into the loan. This mortgage insurance premium(MIP) is relatively expensive as compared to loans insured by private mortgageinsurers. For all the benefits that FHA mortgage programs offer, it is stilladvisable for a borrower to use conventional financing whenever possible.
With all of the options available, it is important for consumers to beinformed of the choices by a qualified mortgage loan officer. The majorcriteria in deciding which MI plan to use are: loan-to-value, cash position,and expected holding period of the home and the loan. A seller concessionfor single premium MI is an effective way to avoid MI expense, when possible.
Dropping Mortgage Insurance
Nearly everyone asks when mortgage insurance can be dropped. Unfortunately,there is no perfect answer. Most mortgage insurance policies require thatmortgage insurance stay in place for a minimum of two years, and that themortgage loan has been paid on time for the two years prior to the cancellationrequest. After that point, when the loan-to-value on a home drops below80%, the borrower must first pay for a licensed appraisal of the propertyto verify the property value. Then the borrower must request that the policybe cancelled in writing to the lender and that lender will consider theborrower's request. However, some lenders and investors will require MIcoverage until even lower LTVs are reached, or until the loan is paid off.Others, on the other hand, may be more lax and only require one year ofon-time payments. Because loans are routinely bought and sold on the secondarymarket, it is impossible to guarantee anything. Lenders remember the disastrousdecline in property values during the late 1980s and are more careful aboutbeing protected. For most borrowers, however, if a strong case can be madethat the LTV has dropped below 80% (either through appreciation in valueor loan repayment), then the MI coverage will be dropped.
Mortgage insurance is a critical element of the American dream. Witha little bit of information and planning, decisions can be made that areappropriate to an individual borrower's financial position and future plans.
Kirk A. Hagert is a wholesale account executive with First BankersMortgage Services in Glastonbury, CT, and a former employee of MortgageGuarantee Insurance Corporation (MGIC).