The Ins and Outs of Mortgage Insurance
Posted Thu, 2010-03-25 10:39 by Emily Caryl
I've recently received a ton of questions about mortgage insurance from borrowers and loan officers. What is it? How much does it cost? When do I need it? Over the next few days, I'll explore the basics of private mortgage insurance, available products, and guidelines for qualifying.
Now, I realize this topic is a little dry for most folks. So here's a little something to make you smile while you read.
Horning's Hideout1
What is Mortgage Insurance?
Mortgage insurance (MI) is an insurance policy that protects the lender in the event a borrower stops making his or her monthly payments. Mortgage insurance is usually required for loans when the homeowner has less than 20% equity in the property. These loans are considered risky because the borrower has a minimal investment in the property. Statistics show that homeowners with less than 20% invested in a home are more likely to default on their loan. Mortgage insurance helps offset the risk of default to the lender.
Most mortgage loans made to borrowers who have less than 20% equity in their home require mortgage insurance. Conventional loans (those conforming to Fannie Mae and Freddie Mac guidelines) are insured by private companies. Hence the term, private mortgage insurance (PMI). Government loans (FHA, VA, and USDA Guaranteed Rural Housing) have their own version of mortgage insurance. But in this blog post, I'll focus on private mortgage insurance required by conventional loans.
Where Do I Get Mortgage Insurance?
If you're purchasing or refinancing a home and mortgage insurance is a requirement of your loan, your lender will obtain the MI for you. Your lender should help you understand the level of coverage required for your loan and the cost.
Fannie Mae and Freddie Mac set the standard for the level of insurance that is required for conventional loans. The level of coverage is determined by two factors: loan to value and the loan term. Loan to value (LTV) refers to the ratio of mortgage liens as a percentage of the value of a property. An $80,000 mortgage secured by a home valued at $100,000 has 80% LTV. A loan's term is the length of time expected to fully repay the loan. Many mortgage loans have a 30 year term.
Mortgage loans with a higher LTV (a lower percentage of equity) require more mortgage insurance coverage than loans with lower LTVs (a greater percentage of equity). In addition, loans with a longer term (25 years or more) require more MI coverage than loans with a shorter term (20 years or less).
Although mortgage insurance protects the lender, the premiums are paid by the borrower. The cost of the premium is determined by the loan purpose (purchase or refinance), occupancy (primary residence or second home), and loan amount. In addition, borrowers who are less creditworthy will pay higher premiums. Since the dollar amount of premiums is expressed as a percentage of the loan amount, a borrower with a larger loan amount will pay a higher premium.
Are There Alternatives to Mortgage Insurance?
Can you avoid mortgage insurance if you have less than 20% equity in your home? Maybe, but it's not likely. In years past, most borrowers avoided mortgage insurance by obtaining two separate mortgages. If a borrower purchased or refinanced a home valued at $100,000, he could obtain a first mortgage for $80,000 and a second mortgage (or line of credit) for $10,000. In essence, the second mortgage was a substitute for a down payment. Because the borrower's first mortgage didn't exceed 80% LTV, he wouldn't be required to obtain mortgage insurance.
In fact, just this past weekend, I happened to catch The Clark Howard Show on television. Clark recommended just such a scenario. He suggested avoiding mortgage insurance by obtaining an 80-10-10 or 80-15-5 mortgage. This means you obtain a first mortgage at 80% of the value of the home and a second mortgage for 5-10% of the home's value.
The problem? In today's lending environment, second mortgages and lines of credit are few and far between. There are a few lenders who still offer second mortgages. But most of these lenders require that the combined balance of all mortgage loans not exceed 80% of the value of the property.
There is another option: portfolio loans. A portfolio loan is one that is held in the bank's investment portfolio. It is not sold on the secondary market and is therefore not subject to Fannie Mae and Freddie Mac guidelines. Many portfolio loans do not require mortgage insurance.
Are portfolio loans a viable option for most borrowers? In my experience, no. First, many banks don't offer portfolio loans. Secondly, because the loan is held by the bank instead of being sold, qualifying guidelines are often more strict than those for conventional loans. Additionally, many portfolio loans come with higher interest rates which result in a monthly payment that is larger than a conventional monthly payment with mortgage insurance. If you wish to investigate a portfolio loan, shop carefully and work with a lender who can help you compare the cost of a portfolio loan to the cost of a conventional mortgage.
How Much Does Mortgage Insurance Cost?
It depends. There are many different mortgage insurance products available. Some MI products require premiums to be paid monthly. Some MI products allow premiums to be paid in one lump sum. Tomorrow, I'll compare the costs, advantages, and disadvantages of different mortgage insurance products.
Questions, comments or concerns about mortgage insurance? Contact Emily Caryl or post your comments below.
1. "Smile," written by Justine Frischmann and Donna Matthews, performed by The String Cheese Incident, Horning's Hideout, North Plains, OR, August 5, 2005.
Post new comment