Get Inside: Solving the Mortgage Mystery

Just What IS Mortgage Insurance, Anyway?

If you have ever found yourself wondering about mortgage insurance, you are in good company.  If I was to make a list of the questions that I have been asked the most frequently over the past 20 years, the very top of the list would include:

• What is mortgage insurance?
• What does mortgage insurance do?
• How much does mortgage insurance cost?
• Will I need to pay for mortgage insurance?
• Can I ever get rid of mortgage insurance?

The truth is, it is not only borrowers who find themselves mystified when it comes to the topic of mortgage insurance; many loan officers and bankers struggle with the same questions, so you are not alone.  It’s time to solve the mortgage insurance mystery!

 What is mortgage insurance and what does it do?

Mortgage insurance is a protection for the bank.  It is a policy that allows the mortgage lender to recover part of their financial losses if a borrower fails to re-pay a loan and the lender suffers a loss on the foreclosure.

For some background:  Banks will usually ask that the borrower have 20% down payment or equity in their property.  Why?  This equity cushion can help the bank in the event of foreclosure.  For example, if someone has a mortgage at 80% of the fair market value, and they default and the property is eventually foreclosed on and the bank tries to sell the home at auction, theoretically they can sell the property for an amount to cover the loan, the accrued interest, any late fees, attorney charges and legal fees, etc.  It also can afford limited protection for the bank in the situation of declining real estate values, a climate that we have been dealing with since late 2007 in certain areas of the country.  There is also the real and psychological benefit of “skin in the game”, also known as the borrower has more to lose and therefore might work harder to keep their home.  

Many homebuyers do not have 20% or more to put down when they purchase a home, and that is where the real beauty of mortgage insurance shines.  A loan can be done with less than 20% if the bank can obtain mortgage insurance to cover potential loss.

There are different kinds of mortgage insurance, government and private.  The various programs backed by the government offer guarantees to the bank, and they are through the Veterans Administration (VA) for qualified veterans including those in the National Guard, Federal Housing Administration (FHA) for those buying a primary residence under a certain loan amount, and Rural Development (RD) for those who meet maximum income criteria and whose intended property is located outside of certain, heavily populated metropolitan statistical areas.  For those who might not want or who do not qualify for the government programs, private mortgage insurance is offered through companies such as MGIC, PMI, Genworth, Radian, RMIC and United Guaranty.    It is the bank who chooses which private mortgage insurance company they wish to use, but you aren’t missing out on much when you can’t choose your own company, as the companies all charge similar premiums, and the qualifying criteria are closely aligned across the board.  (There are occasions when one company might allow something that the others won’t, so having access to multiple PMI companies is an advantage and has allowed me to assist with certain transactions that might have hit a roadblock otherwise.)

What mortgage insurance ISN’T:

Mortgage insurance is not property insurance or hazard insurance, it does not protect your real estate.  It is not a life insurance which will pay the balance of your loan in the event of death, it is not a disability insurance which will make your payments in the event you are unable to work.  It does not protect you in any way.  It does nothing for you, EXCEPT, it does give you a house to live in now, even if you do not have 20% saved or access to a gift of 20%.

How much does mortgage insurance cost?*

At the time of this writing, the costs for a few of the more popular scenarios are as follows:

VA funding fee for 0% down loans = 2.15% of the loan amount (which can be financed), no monthly insurance payment added.  (For example, a loan amount of $200,000 x 2.15% = $4300 upfront cost + $200,000 = $204,300 total loan amount, amortized over loan term at going loan rate).

FHA with 3.5% down = 1% of the loan amount up front (which can be financed), with a monthly premium of .90%.  (For example, a loan amount of $200,000 x 1% = $2000 upfront cost + 200,000 = $202,000.00 x .90% / 12 = $151.50 per month)

RD funding fee for 0% down loans = 3.50% of the loan amount (which can be financed), no monthly insurance payment added.  (For example, a loan amount of $200,000 x 3.50% = $7000 upfront cost + $200,000 = $207,000 total loan amount, amortized over loan term at going loan rate).

PMI with 5% down loans = No upfront cost, but monthly insurance at a factor of .94%.  (For example, a loan amount of $200,000 x .94% / 12 = $156.67 per month)

There also exists an option for Lender-Paid mortgage insurance, which will forgo the monthly mortgage insurance premium, but the interest rate might be higher by .25%.

Will I need to pay for mortgage insurance?

The best way to avoid mortgage insurance is to have a down payment large enough to avoid the need of insurance, or have sufficient equity if you already own the property to be mortgaged.  Other alternatives exist using gifted funds, seller funded second mortgages, or using equity in other real estate owned.  If mortgage insurance is needed, even though it is for the benefit of the bank, the cost gets passed along to you.  The lender-paid mortgage insurance option doesn’t require that you pay for the insurance per se, but you are basically paying for it through a higher rate to the lender.

Can I ever get rid of mortgage insurance?

Yes!  The Homeowner’s Protection Act of 1997 made it mandatory that lenders drop the private mortgage insurance from loans that had a history of being paid as agreed, once they reached a 78% loan-to-value.  At an 80% loan-to-value, the borrower can actively request that the insurance be dropped and not have to wait for the automatic release from insurance at the point of 78% LTV.  (This is advised as it could save 1-2 years of insurance premiums!)  The downside is that the loan-to-value calculation is based on the original acquisition cost, or appraised value from when you first were granted your loan.  If you have done improvements to your home, or you feel that the value has increased through regular market appreciation, you may want to ask that a review be done to see if you might be at an 80% or lower loan-to-value based on the current value.

The funding fee charged at closing by the VA and RD is non-refundable, even if you pay the loan in full one month after closing.  A portion of the FHA upfront fee might be credited if you have an older, existing FHA loan and you refinance into a new FHA loan.

Deciding on the best option for you is an exercise in analyzing your current budget requirements, probable length of time you will keep the home, probable length of time you will keep the loan, projected prepayments on principal, possible property appreciation, and the likely “freedom date” where you might be at a loan-to-value of 80% or lower.  This is an area where your mortgage advisor can add significant value by suggesting your most advantageous options.

Not everyone loves to talk about mortgage insurance, but at MDI Mortgage, we sure do!  Please let us know what additional questions you may have – we are happy to help and are always ready to decipher the jargon!

  ~Sherri Dyer, Advisor & Mortgage Maven

writing for MDI Mortgage, a full service mortgage company located in Bar Harbor, Maine, Mount Desert island

March 10, 2011 at 7:27 PM 2 comments