*Editor’s note: Updates on PMI and MIP rules are asterisked below. For the most up-to-date information, please leave a comment below or email us at ZingBlog@QuickenLoans.com and we’ll answer your questions!
Many homeowners pay it and many home buyers try to avoid it…mortgage insurance. You may be wondering, “What is mortgage insurance and why do I have to pay for it?” Conventional mortgages have private mortgage insurance (PMI) and FHA loans have what’s called mortgage insurance premium (MIP). Here’s more information on both and how they may affect your payments when you purchase a home or close on a mortgage refinance.
Private Mortgage Insurance (PMI)
As part of the loan qualifications set out by Fannie Mae and most investors, a borrower is required to pay PMI when at least 20 percent of a home’s purchase price is not provided as a down payment. Private mortgage insurance is paid by the borrower, but it benefits the lender. It protects the lender against loss if a borrower defaults on a loan.
Lenders view the down payment as additional evidence that you are financially prepared to take on the debt of a monthly mortgage payment. The larger the down payment, the more you can prove to the lender that you will not be at risk of joining the default statistics.
When obtaining a mortgage, it’s important that you find a loan that fits your specific situation and goals. You may have to get a mortgage that requires paying PMI, but it’s also possible to obtain more than one loan and avoid paying PMI.
PMI is usually about one-half of one percent of the loan amount. So if you bought a home for $200,000 and put 5 percent down ($10,000), the annual cost of PMI on your $190,000 mortgage would run approximately $950 a year, adding an extra $80 to your mortgage payment each month.
Alternatively, you could avoid PMI by taking a first mortgage to 80 percent of the loan amount and a second mortgage for the remaining balance. You would instead have an 80-15-5, where 80 represents your first mortgage; 15 represents the second mortgage; and 5 represents the percentage of your down payment. But this structure doesn’t necessarily mean your payment will be $80 cheaper if you avoid PMI. Instead, you will have the additional payment of your second mortgage which could be more than the PMI. However, the benefit of this strategy is that interest is tax deductible but PMI is not.
The good news is that if you must take a loan with PMI attached, you can call your lender to cancel it once you’ve reached 20 percent equity in your home. If you haven’t proactively called your lender to cancel, the Homeowners Protection Act of 1998 requires lenders to automatically discontinue it when you’ve reached 22 percent equity.
Mortgage Insurance Premium (MIP)
While conventional loans have more strict underwriting guidelines, FHA-insured loans require a small amount of cash to close a loan. As a result, all borrowers must pay a MIP to insure the lender against loss if the homeowner defaults on the mortgage. While there are ways to avoid PMI with conventional loans, there is no way to avoid MIP on FHA loans because the down payment is only 3.5 percent.
For loans originated as of October 4, 2010, if your FHA term is more than 15 years, your monthly mortgage insurance payments will be cancelled when the loan-to-value (LTV) reaches 78 percent. This is calculated based on the original value of your FHA home loan and only if you paid the annual MIP amounts for at least five years. If the term of your FHA loan is 15 years or less, with an LTV of 90 percent or greater, the monthly mortgage insurance payments will stop when the LTV reaches 78 percent. Mortgages with an LTV of 89.99 percent or less will not be charged annual mortgage insurance premiums.
For lenders, it’s true that insurance replaces the unknown with security. For home buyers and homeowners, the best strategy is to obtain a mortgage that meets your needs, your pocketbook and your financial goals.
*On April 18, 2011, FHA made a change to their MIP factors which impacted the 15-year loan. Now, there is MIP on loan to values (LTV) greater than 78 percent. (LTVs less than or equal to 78 percent do not require MIP). If you receive conflicting information from lenders you have spoken with, it may be because the mortgagee letter published by FHA didn’t clearly state that there would be no MIP for LTVs less than 78 percent. FHA subsequently stated in an email addressing it, but not in a formal mortgagee letter…yet. We are expecting a mortgagee letter being published about it some time in the future. However, not all lenders have followed suit with the 0 percent MIP on LTVs less than 78 percent.
*Effective June 3, 2013, FHA will require MIP to be paid for 11 years if your original LTV is 90% or lower and for the life of the loan if you are over 90%. For more details, visit this post.