When we bought our first home in 2000, one of the most irritating aspects was having to pay mortgage insurance. I kept arguing that it didn’t make sense to ask me to pay to insure the lender against their own poor judgment in making a loan. Lending is their business and if they are doing their jobs correctly then mortgage insurance should be unnecessary.
While I now have a better understanding of the role mortgage insurance plays there is little point in a borrower paying it unless they have to. After all mortgage insurance is of little benefit to a borrower; aside from the fact that the availability of insurance is what allows borrowers with less than 20% down payment to purchase a home.
There are two different forms of mortgage insurance, the Mortgage Insurance Premium (MIP) and Private Mortgage Insurance (PMI), and it’s important to understand the difference between them.
A Mortgage Insurance Premium (MIP) is required for all Federal Housing Administration (FHA) loans regardless of down payment. Actually, there’s an Upfront Mortgage Insurance Premium (UFMIP) and a monthly Mortgage Insurance Premium (MIP).
The Upfront Mortgage Insurance Premium (UFMIP) on 15 and 30-year purchase and refinance transactions is 1.75% of the loan amount.
Consider a $200,000 home purchase with 10% down (90%LTV). The Upfront Mortgage Insurance Premium (UFMIP) would be $3,150. The entire balance of the UFMIP must be paid in cash or financed at closing. Keep in mind, UFMIP is partially refundable when refinancing to a new FHA mortgage for up to 3 years after the UFMIP close date.
The monthly MIP is also a percentage of the outstanding loan amount divided into 12 monthly payments. Here’s the current calculation for MIP for 30-year and 15-year loans.
|Annual MIP for 30-year loans||Annual MIP for 15-year loans|
|.80% if Loan-to-Value (LTV) is equal to or less than 95%||.45% if Loan-to-Value (LTV) is equal to or less than 90%|
|.85% if Loan-to-Value (LTV) is greater than 95%||.70% if Loan-to-Value (LTV) is greater than 90%|
A couple of examples:
- A $200,000 home purchase (FHA 30 year fixed) with 10% down (90%LTV) at 3.750% (4.512% APR) would have a MIP starting at $119.10 per month.
- A $200,000 home purchase (FHA 30 year fixed) with 3.5% down (96.5%LTV) at 3.750% (4.662% APR) would have a MIP starting at $135.68 per month.
I don’t know about you but I can think of a lot of things to do with that money every month that doesn’t involve paying insurance.
There was a time when a borrower could request cancellation of MIP once a certain LTV threshold was reached and 5 years of payments had been made. Or the MIP would automatically be canceled once the LTV reached 78% of the original value.
Those rules have changed and the FHA now collects MIP for “the maximum duration permitted under statute”. It essentially allows the FHA to collect more money over a longer period of time with fewer, or no, options for cancellation.
Under the new rules, there are two different scenarios based on the original LTV and how much money a borrower puts down.
- If the original LTV was equal to or less than 90% the FHA will collect MIP until the end of the mortgage term or for the first 11 years of the mortgage term, whichever occurs first.
- If the original LTV was greater than 90% the FHA will collect MIP until the end of the mortgage term.
Plainly stated, if a borrower can afford to put down 10% or more for the purchase they will pay MIP for the first 11 years of the loan. If a borrower puts down less than 10%, which most FHA borrowers do, they will pay MIP for 30 years or the full term of the loan.
Let’s take a look at how this impacts borrowers with 30-year loan terms for both situations.
- A $200,000 home purchase (FHA 30 year fixed) with 10% down (90%LTV) at 3.750% (4.512% APR) would have a MIP starting at $119.10 per month. Over the first 11 years of the loan, the total MIP payment would be more than $14,000.
- A $200,000 home purchase (FHA 30 year fixed) with 3.5% down (96.5%LTV) at 3.750% (4.662% APR) would have a MIP starting at $135.68 per month. Over the 30-year term of the loan, the total MIP payment would be more than $20,000.
If that doesn’t motivate you to get rid of MIP as soon as possible I don’t know what will.
So what are your options?
If you are just starting to shop for loans take a good look at conventional loans. There are a number of competitive programs including low down payment options like 3% down and even 1% down. You’ll still be paying mortgage insurance if you put down less than 20% on a conventional loan but you’ll have greater flexibility in eliminating the mortgage insurance.
If you currently have an FHA loan take a look at your equity and the value of your home. When your equity and value combined reach a point where you can refinance to a conventional loan (80% LTV) without having to pay mortgage insurance then it is time to consider a refinance.
This is precisely what my wife and I did. We had a 30-year fixed FHA loan that we converted to a 30-year fixed conventional loan without PMI as soon as we had 80% LTV in the home. The refinance paid for itself in about a year then we used the extra money to overpay on the mortgage.
Private Mortgage Insurance (PMI) is insurance lenders charge to borrowers who are putting less than 20% down on a home purchase with a conventional home loan. Traditionally lenders would only lend up to 80% of the value of a property. The thinking was that borrowers who invested the 20% down payment were more likely to continue making payments which reduced the risk of borrower default.
Fannie Mae and Freddie Mac also require mortgage insurance for all home loans with less than a 20% down payment.
Like MIP, PMI has a recurring premium paid monthly with your mortgage payment. Also like MIP, PMI is insurance for the lender and has little benefit to the borrower.
The PMI calculation is based on a number of different variables including the base LTV, the term of the loan (15 or 30-year), the type of loan (fixed v. ARM) and the amount of coverage necessary.
Here’s the same example we used previously but as a 30-year fixed loan with PMI.
- A $200,000 home purchase (30-year fixed conventional) with 10% down (90%LTV) at 4.250% (4.528% APR) would have a monthly premium starting at $61.50 per month.
The amortization of the loan to 80% of original value would take 72 months, assuming no property appreciation. The total cost of PMI for that period would be $4,428.
Why 72 months?
Once the LTV on the property has reached 80% (pending a lender approved appraisal) a borrower can request cancellation of PMI. Even without requesting cancellation the lender has to remove PMI once the LTV has reached 78% of the original price. In this example, it would take a borrower 84 months of payments to reach 78% LTV and have PMI canceled automatically.
Again that assumes no increase in property value. If the value of the property does increase a borrower could request cancellation of PMI as early as 2 years after the loan origination.
Typically PMI is added to a mortgage payment but lenders offer different options for paying PMI. Which option is right for you will depend on your specific situation and goals.
A borrower who has the available cash could opt to pay all of the mortgage insurance as an upfront fee avoiding the monthly premium. This option means a lower monthly payment but could be more expensive in the long run when you consider the lost opportunity to potentially cancel PMI early.
Borrowers who do not have the available cash can still opt for a one-time PMI premium with no monthly payment but they will have to accept a higher rate from the lender. This option is sometimes referred to as Lender Paid Mortgage Insurance (LPMI). The upside with this option is that the borrower will have a lower monthly mortgage payment because the premium is spread over the life of the loan. The downside is that the payment is spread over the life of the loan and will not be canceled. This may be an attractive option for buyers who will only be in a home for a few years or are planning to refinance after a few years.
If you are paying PMI on a conventional loan pay close attention to your equity and the value of your home. When your equity and value combined reach a point where you can refinance to a conventional loan (80% LTV) without having to pay mortgage insurance then you should consider a refinance.
For more information contact Aaron Walker or Jay Rapson at Aaron Lending, LLC.