Private Mortgage Insurance
Private mortgage insurance or MI is a type of insurance provided by a private mortgage insurance company to protect a lender in the event of default on a loan. This type of insurance is generally required when a borrower has less than 20% equity in a home; i.e. the loan amount divided by the property value is 80.01% or greater.
Who pays for private mortgage insurance?
The borrower pays for mortgage insurance on a monthly basis in addition to the principal and interest payments that are made on a loan. The lender then transfers these premium payments to the mortgage insurance company.
Besides a monthly premium, are there any upfront fees to pay?
Yes. MI companies offer several options to the borrower at the time of closing. A monthly premium plan requires two monthly premiums be paid during the closing, with a set monthly premium due thereafter as part of the required mortgage payment.
An annual plan requires one year of premiums paid at time of closing, with a lower monthly premium due thereafter.
It is generally recommended that the borrower choose the lower upfront insurance premiums at time of closing with a slightly higher per month premium due thereafter.
Do I have to pay mortgage insurance if I have less than a 20% down payment for a home?
No. There are several ways to avoid private mortgage insurance premiums.
The first is to purchase a home with a combination first and second mortgage. The first mortgage would be limited to 80% of the home's appraised value. The second mortgage, which would close in conjunction with the first, would then provide for the difference between the home's purchase price, less the 80% first mortgage, less the down payment available . In other words, if you have a 10% down payment available, your first loan would provide for the 80% mortgage with a second mortgage of 10%. This is commonly referred to as an 80 -10 -10 transaction.
Another way to avoid incurring MI payments is to find a lender that offers self-insured programs. This type of loan would have a higher interest rate in place of the private mortgage insurance premium. While mortgage insurance premium payments are not tax deductible, the interest associated with a self-insured mortgage would be fully tax deductible.
The decision of whether to obtain a loan with mortgage insurance versus the above two options should take into account the combined total monthly payments of the various options, adjusted for the tax benefits of interest deductions.
Once my loan to value ratio drops below 80%, can the MI be removed?
Yes. Lenders will allow borrowers to remove the MI requirement once the property's appraised value increases such that the loan to value ratio is below 80%. The reality of trying to accomplish this can be somewhat challenging. Usually the lender will require that an appraisal be done by the lender's approved appraisal companies. Contact your current mortgage holder to determine their policy on removing mortgage insurance from an existing loan.
Another means to remove the MI is to refinance the original mortgage with the higher appraised value used to determine the new loan's loan to value ratio. However, if the current first mortgage held by a borrower is at favorable terms, it is definitely worth working with the current mortgage holder to eliminate the MI premium.