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Things You Should Know About Mortgage Insurance

Ginny…I’m trying to get a better understanding of private mortgage insurance (PMI). I understand the fundamentals and that it usually equals 1/2 percent-1 percent of the mortgage, but what I’m not sure about is how it is paid.

Is the PMI paid each year until you reach the 20 percent mortgage-to-value ratio? Can you elect to pay the PMI upfront if you do not want the cost of the policy to be included in your monthly mortgage payments?
If you are allowed to pay PMI upfront, instead of monthly, do you have to pay the full premium at the beginning of each year?  Anthony D’Agostino, Pt. Pleasant, NJ

Anthony.. When you put less than 20 percent of the purchase price down on a home, your lender will charge you for the costs of placing a private mortgage insurance, or PMI, policy on your home loan. Though the borrower pays for it, the policy actually protects the lender in the event that the borrower defaults on the loan — a risk that is statistically more likely to damage the lender’s interests when there is little equity in the property.

1. PMI details differ based on whether your loan is FHA or conventional. FHA loans, attractive due to their low, 3.5 percent minimum down payment requirements, actually require two separate forms of mortgage insurance: upfront MIP (UFMIP) and annual MIP (MIP).

Upfront MIP (1 to 1.75 percent of your loan balance) is usually rolled into your FHA loan’s balance and paid as part of your monthly mortgage payment. Under this normal arrangement, the borrower is charged interest on it and is able to deduct the mortgage interest that the UFMIP accrues along with the mortgage interest on the rest of the mortgage balance.

Annual MIP (1.15 to 1.5 percent of your loan balance every year) is imposed on an annual basis on all FHA loans longer than 15 years, but is billed to the borrower in monthly installments.
Conventional (non-FHA) loans have only an annual, or ongoing, PMI requirement.

2. Another set of rules governs cancellation of MIP and PMI. Generally speaking, lenders are required by law to cancel mortgage insurance (and stop charging you for it) once the loan amount is at or below 78 percent of the original value of your home — its value at the time you bought it. This does play out a bit differently, though, with FHA vs. conventional loans.

Conventional lenders are required to automatically cancel the PMI policy when you pay your loan down to 78 percent of your home’s original purchase price or appraised value (whichever is lower). However, conventional loan borrowers may request that PMI be canceled anytime they can document the following four conditions having been met:

Their mortgage balance is 80 percent of the original value of the property.
The borrower has a good payment history.
The borrower can certify that no subordinate loans are on their home.
The borrower can provide evidence (described by the lender in its annual notice) that the property value of her home has not declined.

Some conventional lenders will even consider a new appraisal showing that the home’s value has increased enough to render the loan balance 80 percent or less of its current value, and use that as the basis for removing PMI.

With FHA loans, though, even if and when your home loan scenario meets the 78 percent standard, you must also have been paying annual MIP for at least five years (60 months) for the MIP to be canceled.

For example, if you paid $100,000 for your home, when your loan is paid down to $78,000, your PMI will be automatically removed — unless you have an FHA loan, in which case it will be removed only after your loan balance is down to $78,000 and you have paid the MIP premium for at least five years since you took out the loan.

3. You do have some flexibility in how you pay for PMI. If your home loan is “conventional,” as we discussed earlier, there is no upfront PMI payment required. Conversely, all FHA home loans have an upfront MIP premium — the confusing part is that this is normally paid in monthly installments (even though it’s called “upfront”). If you want to pay your UFMIP in cash at closing, though, you are welcome to do that.

Unfortunately, there’s no across-the-board guarantee that you’d be allowed to pay your annual MIP on an FHA loan in yearly installments, versus monthly. Whether you’d be allowed to do that in any given case would probably be your individual loan servicer’s call. However, the FHA guidelines require that the monthly installment on the annual MIP be calculated into your monthly debt-to-income ratios, which may decrease the home loan amount for which you qualify.

(Ostensibly, the FHA doesn’t want to rely on your word that you’ll always pay the MIP annually — since it is a requirement, FHA will qualify you on the basis of a monthly MIP payment).

Frankly, the better financial decision would be to keep your lump sum of cash in the bank and earn interest on it, just doling out the monthly installment toward PMI as it comes due.

If you’re getting a conventional loan, though, you do have a number of alternatives for eliminating PMI.

First, you might be able to take a home equity line of credit to boost your down payment up to 20 percent, and avoid having PMI entirely.

Second, you can explore the option of something called “single premium mortgage insurance,” a 1-2 percent one-time payment you make at closing that pays for your mortgage insurance upfront in one single lump sum, on top of your other closing costs.

Both of these modes of avoiding MI in your monthly payment may help buyers who are struggling to qualify for the purchase price target because the mortgage insurance cost is pushing their mortgage payments beyond what loan guidelines say they can actually afford.

Third, there are loan programs that allow for LPMI (lender-paid mortgage insurance) wherein you pay a higher mortgage interest rate for the life of the loan, and your lender pays the entire mortgage insurance premium (your mortgage interest is fully tax deductible, remember). Alternatively, you can take a traditional buyer-paid mortgage insurance-backed loan, and simply elect to pay your yearly PMI premium on an annual, lump-sum basis, at the beginning of every year.

Both these payment methods prevent the PMI premium from being added into your monthly mortgage payment, but they do little or nothing to help you afford a higher-priced home than simply paying a regular PMI monthly installment.

One thing: Some homeowners have the concern that paying PMI upfront or annually would result in a forfeiture of funds if your home’s equity hits the 78 to 80 percent mark after payment has been made. The Homeowners Protection Act of 1998 expressly provides that “if the borrower has paid for private mortgage insurance in advance at closing or is currently paying on an annual basis, upon cancellation they are entitled to a refund of the unearned premium, which must be transferred by the lender within 45 days of cancellation notification.”

That said, there is some danger that once you’ve paid your premiums upfront or annually, PMI will be both out of sight and out of mind. So, there is some danger that you might not be as aggressive about tracking your home’s equity and applying for PMI cancellation if you have prepaid it as you would be if you were having to pay it every month. If you do decide to prepay or annually pay your ongoing PMI premiums, be sure to carefully watch your home’s value and your mortgage statements and apply to have your PMI canceled as soon as you think you qualify.