Mortgage Insurance

Mortgage Loans: Private Mortgage Insurance

Private mortgage insurance protects the lender against financial loss if a homeowner stops making mortgage payments. Lenders usually require mortgage insurance on low down payment mortgage loans (less than 20%) for protection in the event that the homeowner fails to make monthly payments. Although the cost of the mortgage insurance is paid by the home buyer, the mortgage insurer works directly with the mortgage lender. Mortgage insurance is available to commercial banks, mortgage bankers, and savings and loans, and all of which offer mortgage loans to home buyers.

Government Insurance and Private Insurance

Low down payment mortgages can be insured in two ways — through the government or through the private sector.

Mortgages backed by the government are insured by the Federal Housing Administration (FHA) or guaranteed by the Department of Veterans Affairs (VA) or the Farmers Home Administration (FMHA).

The minimum down payment required by FHA is less than 3%. For single-family homes, the standard limit for an FHA-insured mortgage ranges from $86,317 to $170,362 (in certain high-cost areas).

Although anyone can apply for FHA insurance, the other two government mortgage guarantee programs are much more targeted. The VA program is limited to qualified, eligible veterans and reservists. The FHA insures loans for the construction and purchase of homes in rural communities. This program is very specialized, so contact your lender for more information.

Obtaining conventional financing is the alternative to obtaining a home loan backed by the government. Conventional mortgages are all home loans not guaranteed by the government, including those guaranteed by private mortgage insurers.

Government vs. Private Insurance

Although government and private insurance are based on the concept of allowing families to get into homes with less cash down, there are many differences between the two. Often, the lender or loan originator will play an important role in suggesting and deciding which insurance is selected.

Home buyers must make a down payment of at least 5 percent of a home’s value to be considered for private mortgage insurance. The down payment requirement drops to 3 percent for special affordable housing programs geared toward first-time, lower-income buyers.

Private mortgage insurance is available on a wide variety of home loans and there is no pre-set limit on the loan amount. Although differences such as these may affect whether the lender prefers to work with government or conventional mortgages, your lender will discuss which one would be better for your situation.

Lender Paid Mortgage Insurance (LPMI)

You may also be offered “lender paid” mortgage insurance (“LPMI”). Under LPMI plans, the lender purchases the mortgage insurance and pays the premiums to the insurer. The lender will increase your interest rate to pay for the premiums — but LPMI may reduce your settlement costs.

You cannot cancel LPMI or government mortgage insurance during the life of your loan. However, it may be possible to cancel private mortgage insurance at some point, such as when your loan balance is reduced to a certain amount (see next page). Before you commit to paying for mortgage insurance, find out the specific requirements for cancellation.

How to Avoid Private Mortgage Insurance

If you put down less than 20% of the purchase price on a real estate purchase, you will be required to pay for private mortgage insurance.  A method to avoid mortgage insurance is to get a piggyback loan:  get a first mortgage for 80% and a second mortgage (home equity) loan for 10% or 15%.  The interest on your second mortgage might be tax deductible, unlike the cost of mortgage insurance.

What Does Private Mortgage Insurance Cost?

Typically, such insurance costs about $250 to $600 a year on a $100,000 mortgage (about a .3 to .7 increase in your mortgage interest rate), although the average American pays just under $15,000 per year in mortgage insurance.  This adds significantly to your monthly mortgage payment.   The major problem with mortgage insurance is that sometimes the lender never stops charging for it (see “Cancellation of PMI” below), even when the owner’s equity in the home (or LTV ratio) drops below 80 percent and it is no longer mandatory.   If you feel you are no longer required to pay such insurance, contact the lender and ask it to be terminated.  Alternatively, if your home is appreciated in value, thus increasing your equity, you can also have mortgage insurance discontinued; however, you will be required to prove your home has increased in value — meaning, you must pay for an appraisal.   NOTE:  The above article is not discussing mortgage life insurance.  Mortgage insurance covers the lender, not the homeowner and his heirs in the event the homeowner dies.

Cancellation of Private Mortgage Insurance

The Homeowners Protection Act of 1999 requires automatic termination of private mortgage insurance (PMI) on mortgages obtained after July 29, 1999 (both original mortgages and refinancing).  This law doesn’t apply to FHA or VA loans or lender-paid PMI loans.   Your PMI is automatically terminated when you reach 22 percent equity in your home based on the oriignal propery value provided that your payments are current.   There are certain exceptions to this rule. If your loan is considered “high-risk” or you are behind in your payment or have a record of not paying on time or if you have any liens on your property, your PMI does not automatically have to be cancelled.   How much can you save by having your PMI cancelled? On a typical $100,000 mortgage loan, your PMI might cost you about $40 per month or $480 per year.   How to cancel your PMI?  Call your mortgage broker.  In fact, your mortgage servicer is required to provide you with written notice about the above mentioned law on an annual basis.