Mortgage insurance? What is it and why do you need it? For a lack of better words, mortgage insurance or PMI (private mortgage insurance) is really foreclosure insurance. It protects the mortgage lender against the borrower defaulting on the mortgage loan and will pay a certain percentage (coverage amount) towards the remaining balance in the event of default. Mortgage insurance isn’t a bad thing, without it everyone might be forced to have a 20% down payment!
Mortgage insurance is required with most conventional loans when the borrower does not put at least 20% down payment for a purchase or are over 80% loan to value if you are refinancing. Conventional mortgage insurance premiums are very dependent upon credit scores and down payment amount, although credit scores play the biggest role in how much your PMI will cost.
There are a few options when it comes to paying mortgage insurance with a conventional mortgage loan….
Borrower Paid Mortgage Insurance (BPMI) – This is the most common option. The mortgage insurance is charged as an annual rate and paid monthly in the mortgage payment. Borrower paid mortgage insurance automatically cancels when the loan to value ratio reaches 78% loan to value. Typically with a 5% down payment and no additional payments to principal, PMI will automatically cancel between 9.5 and 10 years. Under certain circumstances, your servicing mortgage lender may allow you to cancel PMI sooner by obtaining a new appraisal to show that your loan to value ratio is 80% or less. The appraisal will need to be ordered through your servicing lender and paid for by you.
Single Paid Mortgage Insurance – This option allows the borrower to pay a single amount of PMI as part of their closing cost instead of paying the monthly amount. This can be a great option if you plan on living in your home long enough to realize the savings over the monthly option. Typically the single amount of mortgage insurance paid as part of your closing costs is less than the amount you would pay over 9.5 to 10 years if you do not make any additional payments to principal.
Lender Paid Mortgage Insurance (LPMI) – This option allows the lender to pay for the PMI policy and build that into an increased interest rate. Sometimes this results in an overall lower monthly payment. Since the PMI is built into the interest rate, there is no removing it or obtaining a lower rate unless you refinance your mortgage loan.
FHA, USDA Rural Development & VA Home Loans – These loans are backed by the federal government. With these loan types, the amount of mortgage insurance you pay is the same regardless of credit scores which can allow these options to provide a lower monthly payment for borrowers with lower credit scores. VA loans do not have monthly mortgage insurance payments.
All of these options do require the payment of an upfront amount of mortgage insurance or funding fee that can be financed into the loan. FHA charges 1.750%, Rural Development 1% and VA 2.15% up to 3.000%. If you are a disabled veteran receiving VA disability compensation, you are exempt from paying the upfront funding fee.
No one likes to pay mortgage insurance, however it definitely allows more borrowers become homeowners that would otherwise need a 20% down payment.