Understanding Mortgage Insurance
It’s important to discuss mortgage insurance (MI) with your loan officer so you’re aware of what it is, when you have to pay it and what payment options you have. If you have less than 20 percent down payment, you are required to pay mortgage insurance. Private mortgage insurance is a policy that protects lenders against financial loss if you default on your loan. The assumption is that the less money you invest in your home, the more likely you are to walk away from your loan and the riskier you are to an investor.
The MI premiums are based on your middle credit score (whoever has the lowest middle credit score for joint borrowers) and your loan-to-value ratio.
A quick example of what loan-to-value means: If you put 10% down on your home, your loan-to-value ratio would be 90%. Meaning, you are financing 90% of the home’s value and the remaining 10% is the equity you have in the home.
Individuals with a credit score of 760+ and a loan-to-value ratio of 85% (or 15% down payment) receive the lowest mortgage insurance premium. From there, the premiums increase based on which credit score range (e.g. 720-739) and down payment category you fall into. The lower your credit score and down payment, the higher the premium. Here are the four loan-to-value categories:
- 97% to 95.01% (3% to 4.99% down payment)
- 95% to 90.01% (5% to 9.99% down payment)
- 90% to 85.01% (10% to 14.99% down payment)
- 85% to 80.01% (15% to 19.99% down payment)
There are several ways in which you can pay mortgage insurance. It’s critical to walk through all options with your loan officer to find out which option best fits your financial situation.
THREE WAYS TO PAY MORTGAGE INSURANCE:
- Option #1: Pay it monthly
- Option #2: Buy it out with a single upfront premium — increasing your closing costs
- Option #3: Increase your interest rate — giving you a lender credit that is applied to the buyout costs of mortgage insurance
Let’s look at the different payment methods for the three options above for the following scenario:
250,000 purchase price, 5% down, 4% interest rate (4.689% APR), 740 credit score
- Option #1: Principal & Interest + Monthly MI = $1,316.46/mo.
- Option #2: Principal & Interest = $1,193.54/mo. + single MI premium of $4,375.00
- Option #3: Principal & Interest with higher interest rate of 4.375% = $1,248.21/mo.
Total Cost in Five Years for P&I Monthly Payment + MI Payment Options:
- Option #1: Cost of P&I + Monthly MI = $78,987.60
- Option #2: Cost of P&I + single MI premium = $75,987.40
- Option #3: Cost of P&I with a 4.375% interest rate = $74,892.60
Depending on how long you plan to stay in your home, how much cash you have readily available and how quickly you’ll reach 80% loan-to-value, ultimately determines which option makes sense for you. However, you’ll notice that sometimes taking the higher interest rate (even after 5 years) is the cheaper option. Pretty surprising, right?
WHEN CAN IT BE REMOVED?
In order to request the removal of mortgage insurance, you must show good payment history, no liens against your home and prove 20% equity with a new appraisal (which will typically cost $500) two years from your first payment date. Some clients assume if their appraised value comes back considerably higher than the sales price during their purchase transaction, they can get their mortgage insurance removed quicker. However, you still have to wait the required two year period unless can prove 78% equity instead. Regardless, it’s a good idea to contact your servicing lender for clarification before doing this.
If you don’t request cancellation of mortgage insurance, once you pay the principal balance down to 78% of the original purchase price, the MI will automatically fall off. The good news is you’re not stuck with it forever for conventional loans.
If you have further questions about which payment option is best for you, feel free to contact the Parkinson Group to discuss with us today!