Mortgage Insurance

Chapter Nine: Mortgage Insurance

Learning Objectives

  • Explain the purpose of mortgage insurance.
  • Differentiate between Private Mortgage Insurance (PMI) and Mortgage Insurance Premium (MIP).
  • Explain how a borrower can avoid paying mortgage insurance.

Loan to Value Ratio (LTV)

  • Definition: LTV stands for Loan to Value ratio.
  • Significance: LTV is crucial when discussing mortgage insurance as it assesses the amount of a loan compared to the home's value.
Understanding LTV Ratios
  • A mortgage with a high LTV indicates that the down payment is a low percentage of the sales price, making the loan riskier for the lender.
  • LTV Calculation:
    • LTV is the percentage of the sales price covered by the mortgage.
    • Example Calculation:
    • Sales Price = $200,000
    • Loan Amount = $194,000
    • LTV Ratio = rac194,000200,000=0.97rac{194,000}{200,000} = 0.97 or 97%.
    • To find the down payment:
    • Down Payment = Sales Price - Loan Amount = $200,000 - $194,000 = $6,000.
    • To find the sales price given loan payment and down payment:
    • Sales Price = Loan Amount + Down Payment = $194,000 + $6,000 = $200,000.

Private Mortgage Insurance (PMI)

  • Definition: PMI is insurance paid to a private company by a borrower to protect the lender against borrower default on the loan amount.
  • Clarification: PMI is not aimed at protecting the borrower but is intended for the lender's benefit if the borrower stops paying.
  • Purpose: PMI allows borrowers who might not qualify for a specific loan to secure financing for a home.
  • Requirement: PMI is mandated when the LTV ratio exceeds 80%.
  • Factors Influencing PMI Payments:
    • Borrower's credit score.
    • Amount of down payment.
    • Lender's terms.
    • Market conditions.
  • Alternative Options: Some lenders may allow a higher interest rate in lieu of PMI.

Mortgage Insurance Premium (MIP)

  • Definition: MIP is the FHA's equivalent to PMI and funds FHA insurance.
  • Components of MIP:
    1. Upfront Mortgage Insurance Premium (UF MIP).
    2. Monthly Mortgage Insurance Premium.
  • Requirement: All FHA borrowers must purchase MIP.
Upfront Mortgage Insurance Premium (UF MIP)
  • Percentage: The borrower pays 1.75% of the loan amount at closing as UF MIP.
  • Option: Borrowers can finance this fee with the mortgage.
Annual Mortgage Insurance Premium
  • If the down payment is less than 20%, the borrower will pay the annual mortgage insurance premium divided into monthly payments.
  • Range: MIP ranges from 0.45% to 1.05% of the loan amount.
  • Payment Method: This is paid monthly along with the principal, interest, taxes, and insurance (PITI) payment.
  • Account Usage: Premiums go into an account used by the FHA to cover losses from defaults.
MIP Refunds
  • Certain borrowers may qualify for a refund of their mortgage insurance if they meet the following criteria:
    • Loan acquired after 09/01/1983.
    • Paid an upfront premium at closing.
    • Did not default on the loan.
  • Termination Criteria:
    • Loans before 01/01/2001 must be terminated before the seventh year.
    • Loans on or after 01/01/2001 must be terminated before the fifth year.
  • Determination of Refunds: Based on the number of insured months determined by the FHA commissioner.

Avoiding Mortgage Insurance

  • Borrowers often look for options to eliminate PMI payments.
Reappraisals
  • After a few years, a borrower's home value may have increased.
  • Procedure:
    • Borrowers can request a lender-approved appraiser to assess the new home value.
    • Home value increase can add equity; if it reaches 20%, the borrower can request PMI cancellation.
    • Equity reached at 22% requires servicer to eliminate PMI.
  • Home Improvements: Remodeling or adding features to increase home value can also help.
  • Note: This method is applicable for conventional loans but not for FHA MIP.
  • To cancel MIP, refinancing into a non-FHA insured loan is necessary.
Piggyback Loans
  • Also known as 80/10/10 Loans, these consist of two mortgages.
  • Structure: One loan for 80% of the sales price at a standard interest rate and another for 10% at a higher rate.
  • Example:
    • For a $150,000 home:
    • First loan of $120,000 at 7% interest.
    • Second loan of $15,000 at 9% interest.
  • Advantages: No PMI required, and the interest on the second loan is tax-deductible.
  • Comparison: PMI is cancelable once equity reaches 20%, while piggyback loan obligations must be paid like any other loan.
  • Conclusion: An 80/10/10 loan can reduce monthly payments compared to a single loan with PMI. However, PMI may be more economical long-term if the borrower wants to build equity faster.

Summary of Key Concepts

  • Mortgage types are classified as conventional or government-backed, with conventional loans not insured by the government.
  • Important Definitions:
    • Conforming Loans: Meet guidelines of Fannie Mae and Freddie Mac.
    • Nonconforming Loans: Do not meet such guidelines.
  • Interest Rates: Can be fixed or adjustable.
  • A variety of home loans discussed include straight loans, bridge loans, subprime loans, balloon payment mortgages, and others.
  • Refinancing Benefits: Useful for leveraging lower interest rates or avoiding balloon payments.
  • Equity Loans: Reverse mortgages and home equity lines of credit allow accessing equity as collateral for loans.
  • FHA, VA, USDA: Types of government-backed loans with distinctions in borrower requirements and down payment expectations.
  • Differentiate between MIP and PMI, and understand measures to eliminate mortgage insurance payments.