What is mortgage insurance?
Mortgage insurance is an insurance policy that protects the mortgage company in the event of a foreclosure where the proceeds of the sale are insufficient to pay the outstanding balance on the mortgage loan.
On FHA, VA and USDA loans, the US Government guarantees payment of the loan. On non-government (conventional) loans the policy is issued by a private mortgage insurance company.
When is it required?
Mortgage insurance is required on all government-guaranteed loans and on most conventional mortgage loans when, on a purchase transaction, the borrower’s down payment is less than 20% of the lesser of the purchase price or appraised value, or on a refinance, where the loan amount is greater than 80% of the value of the property securing the loan.
Who pays the premium?
The premium is paid by the borrower on all government-insured loans and can be paid by either the borrower or the lender on a conventional loan. It can also be paid by the seller in a purchase transaction, subject to limitations.
But even where the lender pays the premium, the cost is passed on to the borrower in the form of either additional discount points (more costs paid at closing) or in the form of a higher interest rate, or both.
When is it paid?
On VA loans the premium is only paid upfront in the form of a VA funding fee. On an FHA or USDA loan, the borrower pays both an upfront premium at closing, and a monthly add-on to the mortgage payment.
The premium on private mortgage insurance can be either upfront as a single premium, or monthly, or a combination of both.
VA Funding Fee
The VA Funding Fee is based on branch of service, eligibility and down-payment
The fee is a percentage of the loan amount. Example: 2.15% of a $100,000 loan amount would be a funding fee of $2,150. It is paid as a lump sum at closing but can be financed (i.e. rolled into the loan amount).
On FHA loans the borrower will pay an upfront mortgage insurance premium of 1.75% at closing. Then an annual renewal at the rate indicated below will be paid monthly.
Example: On a $100,000 loan with less than 5% down the borrower would pay $1,750 at closing and the amount of $70.83 per month ($850 annual renewal / 12). The upfront premium can be financed (i.e. rolled into the loan amount). *Loan Amounts greater than $625,500 are not allowed in Texas.
On USDA Rural mortgage loans (Sec 502 loans) the borrower will pay at closing an upfront mortgage insurance premium of 2.75%. Then an annual renewal at .50% paid monthly.
Example: On a $100,000 loan the borrower would pay $2,750 at closing and the amount of $41,67 per month ($500 annual renewal / 12). As with FHA and VA loans, the upfront premium can be financed. Beginning in October 2016 the upfront fee will be reduced to 1% and the renewal to .35%.
Private Mortgage Insurance (PMI)
PMI on conventional loans is offered with three payment options. Upfront only (called single premium PMI), monthly only (monthly PMI) and a hybrid that has both.
The majority of borrowers requiring PMI obtain the monthly variety, but single premium options, which are priced attractively for borrowers with high credit scores, are becoming increasingly popular.
What does PMI cost?
Private companies have used empirical data on defaults to create a complex system of establishing premiums. The most important factors in the determination of PMI rates is the loan to value ratio of the mortgage transaction and the credit score of the borrower. But even the default rates for loans originated by different lenders can affect the premiums. Thus rates for PMI premiums on loans originated at one lender might be higher for the same borrower than PMI rates at another.
Which type of PMI?
A prospective borrower must take PMI rates into consideration when shopping for a mortgage on a transaction where the loan to value ratio will exceed 80% and must consider which of the payment options is most beneficial based on his or her credit scores and the characteristics of his or her transaction.
Generally speaking single premium payment options will provide significant savings for borrowers with excellent credit scores and who anticipate being in the mortgage loan for period of at least 4 to 5 years.
Your choice is important!
A borrower can save thousands of dollars during the term of the loan by choosing the right type of PMI and selecting a mortgage lender with the most favorable PMI rates.
Emphasis on the payment, not the rate
Many borrowers make the mistake of focusing on the rate and the closing costs. But on transactions with a down payment less than 20% a third component becomes even more important than those.
What a borrower will find is that more often than not, a loan with a higher rate, that reduces or lowers the monthly PMI payment, results in a lower payment and is usually the better choice.