Your Vexing Questions Answered…

Adapted from , About.com Guide

There are several types of mortgage insurance, but the type that everybody complains about is private mortgage insurance. That’s because homeowners with private mortgage insurance have to pay a hefty premium for an insurance policy, and it doesn’t even cover them. Private mortgage insurance offers zero protection for the borrower – but – it does allow a borrower to purchase a home for as little as a 3.5% down payment.

A lesser known type of mortgage insurance is the type that pays off your mortgage in case you die, also known as Credit Life Insurance.  You pay a small premium that will pay off your mortgage in the event of your untimely demise.  You probably could get better protection through a life insurance policy. The type of mortgage insurance most people carry is the type that insures the lender in the event the borrower stops paying the mortgage. That’s right, private mortgage insurance insures your lender.

Why Do You Pay for Private Mortgage Insurance?

Many borrowers take out private mortgage insurance (PMI) because Fannie Mae and Freddie Mac requires it. In case you didn’t know, Fannie Mae and Freddie Mac are Government Sponsored Enterprises(GSE) or Companies that are owned by the US Government and these 2 companies purchase just about all of the home loans in the US today and set the criteria for those loans.  The rules or guidelines require it because the borrower is putting down less than 20% of the sales price as a down payment. Obviously, with “skin in the game”, it is less likely for a borrower to default or stop payment on the loan.  The less a borrower puts down, the higher the risk to the lender. So, Fannie or Freddie wants insurance or protection against a default.

You don’t choose the mortgage insurance company and you can’t negotiate the premiums. It sounds almost un-American, doesn’t it? But that’s the way it works when you get a mortgage that exceeds 80% loan-to-value.

If you put down 5%, for example, on a $200,000 home and stopped making your mortgage payments, mortgage insurance would pay your lender $30,000, which is the 15% that you did not put down to protect the lender to an 80% LTV. This would happen after foreclosure.

FHA charges for mortgage insurance as well. Not only do you pay an upfront premium for mortgage insurance, but you pay a monthly premium, along with your principal, interest, insurance for property coverage and taxes.

How Do You Cancel Private Mortgage Insurance?

Once your equity rises above 20%, either through paying down your mortgage or appreciation, you might be eligible to stop paying PMI. The first step is to call your lender and ask how you can cancel your private mortgage insurance.

The lender will want proof that your equity position is secure and exceeds 20%. It will get that proof by requiring you to pay for an independent appraisal. You don’t get a voice in choosing the appraiser or the amount that the appraisal will cost you, but it will probably cost between $350 and $500.

FHA rules are different. If you have an FHA loan, you will need to pay down your mortgage to 78% of your original sales price. Even if appreciation has pushed your equity up, it won’t matter. You will need to reduce your original principal balance.

How Can You Avoid Paying for Private Mortgage Insurance?

There are many ways to avoid paying for private mortgage insurance. You may not necessarily qualify for these nor want to do any of them.

  • If you are a veteran, you can take out a VA loan, which has no monthly mortgage insurance, but does have a Funding Fee of 3.5% added to the loan amount.  The Funding Fee is used as a form of MI and to support the VA loan program.
  • You can put down 20% or more as a down payment. Maybe you could tap the Bank of Mom and Dad?
  • You can pay a higher interest rate. Sometimes the difference in your monthly payment spread out over your planned term of occupancy is much less than paying for mortgage insurance.
  • You can take out a combination loan of 80 / 10 / 10. This consists of a 10% down payment, an 80% first mortgage and a 10% second mortgage.
  • Look into a HomePath mortgage offered by Fannie Mae on select Fannie Mae bank-owned homes.

Realize that there is never a guarantee that your loan will not contain MI if your equity is less than 20% because lenders can pay for MI without your consent or knowledge.

 

Resources

Mortgage insurance – Wikipedia, the free encyclopedia

What is mortgage insurance? – Bankrate.com

How Mortgage Insurance Works

What is Mortgage Insurance For?

PMI – The Federal Reserve Bank of San Francisco

 

1 Comment

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