By Christopher Carter
Mortgages revolve around a 20% down payment, and buyers who put less down use mortgage insurance to do so – yet many don’t understand what that means.
KEY BISCAYNE, Fla. – Mortgage Insurance is one of the most misunderstood topics in real estate.
When buyers use financing and their down payment is less than 20% of the purchase price (or appraised value), lenders require mortgage insurance. Lenders’ tracking studies indicate that when buyers start out with less than 20% initial equity in the property, there is a higher risk of the loan going into default, then into foreclosure. Mortgage Insurance (MI) offsets the risk of lender financial loss.
Real estate’s 80/20 Rule refers to the Loan-To-Value (LTV) ratio, a primary element of all lenders’ risk management. A mortgage loan’s initial LTV ratio represents the relationship between the buyer’s down payment and the property’s value (20% down = 80% LTV).
Here are 3 important points to keep in mind while reading today’s article:
- Mortgage Insurance protects the lender from loss, though the borrower pays the insurance premiums. MI premiums do not go toward principal or interest, they are separate additional charges. Initial LTV (and the need for MI) is determined by the amount of the buyer/borrower’s down payment.
- With less than a 20% down payment, buyers pay MI premiums for coverage that reimburses the lender for its loss if the borrower defaults on the terms of the loan. MI is an additional charge to buyers in conventional as well as government-insured financing programs. Depending on the loan program and MI requirements, premiums might be paid upfront, monthly, or both.
- On conventional (not government-insured) mortgages, those premiums are paid to third-party specialty insurance companies. With government-insured mortgages (FHA, VA, USDA), MI premiums are paid to the insuring government agency.
(Important: The Mortgage Insurance we are discussing today is NOT to be confused with Mortgage Life Insurance, which pays off the remaining mortgage balance in the event of the borrower’s death. They are very different insurance policies used for very different purposes.)
Most people have seen the acronym “PMI,” which stands for Private Mortgage Insurance. PMI is issued by specialty insurance companies for conventional loans in which the buyer/borrower has put down less than 20%. Annual premiums for PMI depend on initial LTV (down payment amount), credit score, property type, and other transaction details. PMI can be structured as a one-time payment at closing (upfront), monthly payments added to scheduled principal and interest payments, or a split plan combining both upfront and monthly.
Mortgage insurance premium structure overview
Note: Upfront MI payments on government-insured loans can be wrapped into the loan amount. Conventional one-time upfront MI must be paid at closing.
Lenders might pay for a borrower’s PMI in exchange for charging a higher interest rate for the life of the loan. Ask your licensed Loan Originator about Lender-Paid Mortgage Insurance (LPMI) and other lower down payment programs.
Under the U.S. Homeowners Protection Act (HPA) of 1999, borrowers may request, in writing, that conventional PMI be removed (and ongoing PMI payments ended) when the loan principal balance is paid down to 80% (there’s that 80/20 Rule again) of the property’s appraised value when purchased. Also under the HPA, lenders must remove PMI when LTV reaches 78% of the property’s original value, as long as payment history has been satisfactory.
Important: This removal procedure ONLY applies to conventional mortgages, not government-insured financing.
The Federal Housing Administration (FHA) is an agency of the US Department of Housing and Urban Development (HUD), a Cabinet-level department of the Federal government. To help make mortgage funding available to a broader range of buyers, the FHA insures independent lenders against buyer/borrower default.
FHA qualifying standards for borrowers are more lenient than most lenders’ conventional loan programs. These standards help buyers with lower credit scores and lower down payments qualify for mortgage financing on primary residences. Lenders are more willing to make loans using these broader qualifying standards when they are protected by FHA insurance.
FHA-insured financing includes both upfront and monthly Mortgage Insurance Premiums (MIP). The upfront portion can be either paid at closing or wrapped into the total loan amount, and is required on all FHA-insured mortgage financing. There is also an annual MI premium that is paid with the borrower’s monthly PITI (Principal, Interest, Taxes, Insurance) payment.
For FHA-insured mortgages, the annual MIP stays in place for 11 years when the initial LTV is less than 90%. This means that buyers putting down more than 10% will be paying monthly MI for the next 11 years unless they refinance or move within that time.
When buyers use a less than 10% down payment, FHA MIP stays in place for the life of the loan. In this case, buyers could be paying monthly MI premiums for up to 30 years, or until they refinance or sell the property.
© Copyright 2023 IslanderNews.com, Key Biscayne, FL. This report was first published in The Florida Real Estate Blog by Chris Carter, a real estate broker associate and former Key Biscayne resident.
