Mortgage insurance (MI). What is mortgage insurance? Do I have to have mortgage insurance? Who shops for mortgage insurance? How is mortgage insurance calculated?
In this post we get to discover mortgage insurance and how it may or may not impact your loan. Mortgage insurance is not there to protect you as a home buyer, but is there to protect the lender in the event that the home buyer defaults on their mortgage payment and is no longer able to make the payment. The mortgage insurance will help cover some of the losses that a lender may incur in these unfortunate events. Among the losses that may be incurred are the costs of selling the home, servicing the loan, or even keeping the home during the foreclosure process among others.
Mortgage insurance is not applicable to all mortgages. If you are a first-time homebuyer, you are likely going to need it so read on. Mortgage insurance requirement vary depending on the loan program. The costs will vary depending on the program or your Loan-to-Value ratio, also known as LTV.
Mortgage Insurance on Conventional Loans
Let’s start with a conventional loan. You are required to have mortgage insurance if you are using a conventional loan and your LTV is above 80%, meaning you don’t have at least 20% down. This does not mean that you need 20% down to qualify for a conventional loan. There is a misconception on required down payments, and I want to clarify 20% is not required for a down payment. The benefit of having 20% down is that you will not need to pay for mortgage insurance on a conventional loan, which will save you money on your monthly payment. Most first-time homebuyers don’t have 20% down. Imagine that…
Did you know the cost of mortgage insurance will depend on the amount of your down AND your credit score? Keep in mind that the credit score a lender uses will be the middle score of the three main credit bureaus (Transunion, Equifax, and Experian). If there are two or more borrowers, the lowest middle credit score of all borrowers will be used. You will find that there are price breaks for every 20 points on a credit score. For example, the percentage used to calculate mortgage insurance costs will be lower at 760 than 740 and so on. Simply put, the better your credit score, the cheaper the mortgage insurance.
The amount of your down payment will also effect the cost of your mortgage insurance on a conventional loan. You will typically find new cost categories at 3%, 5%, 10%, and 15% down payment. With a 20% or more down payment, mortgage insurance will not be required on a conventional loan. The mortgage insurance cost will be more with 3% down versus 10% down. Another way to simply put it, the higher your down payment, the cheaper your mortgage insurance will be. This is because you are coming in with more equity and are viewed as a lower risk to lending.
You will also find that mortgage insurance costs will vary from lender to lender on conventional loans. This is because there are several mortgage insurance providers and they each have their own rates. The lender will decide which mortgage company they use, not the homebuyer. I have seen quotes from other companies that charge more or less than other lending companies. This is another reason why using a mortgage broker, like myself, if helpful in the loan process. Good mortgage brokers are not only able to help you with a good interest rate for your scenario. They are also able to help you find good mortgage insurance rates with the lenders they use.
Do not let a smaller down payment prevent you from purchasing a home. I have read several articles that advise not purchase a home if you don’t have 20% down because you are wasting money on mortgage insurance. While I feel in many cases that mortgage insurance is a waste of money, it is a necessary evil to be able to purchase a home with a lower down payment. I have met clients who have tried to collect 20% for a down payment and by the time they did, home prices were much higher. They would have more money if they would have used mortgage insurance instead of saving enough to get out of mortgage insurance. I have felt bad for these clients because not only did they waste money on rent, but they lost an opportunity to gain equity based on appreciation. They would have saved thousands and in some cases tens of thousands of dollars!
FHA mortgage insurance
FHA loans use a fixed percentage for their mortgage insurance. They also have what is called an Upfront Mortgage Insurance Premium (UFMIP). The UFMIP is collected by FHA at closing and can be financed into the loan amount. The cost of the UFMIP is currently 1.75% of the loan amount. A simple example would be if my loan amount was $100,000. I would expect to pay $1,750 for the UFMIP to FHA. This can be costly.
However, FHA is helpful for borrowers who have less than ideal credit or lower income and can provide an affordable mortgage payment to these borrowers. FHA also generally offers lower interest rates. I’m not going to go through a full comparison on loan programs in this article, but that is coming up in the future. Let’s try to just focus on the mortgage insurance basics.
FHA also require a monthly mortgage insurance payment. If the homebuyer is bringing in 3.5% down, which is the minimum down payment required for FHA, then they will be required to have mortgage insurance for the life of the loan. Most clients will try to refinance out of FHA when they get to 80% LTV so they can get rid of mortgage insurance. The timing of refinancing out of an FHA loan will also depend on what interest rates are doing. We want to make sure interest rates and monthly payments will make sense financially for you when are ready to get out of that FHA loan.
The percentage cost for FHA mortgage insurance is currently fixed at .85% annually based on the initial loan amount. There are some exceptions to those who need to use FHA and have a down payment above 10% to what I have described above.
VA mortgage insurance?
If you are part of our brave and dedicated military, you may qualify for a VA loan. VA stands for Veteran’s Affairs Loan. VA loans do not require mortgage insurance or a down payment. There is a funding fee, which is collected similar to FHA’s UFMIP, to be aware of. The funding fee cost varies on first use, subsequent use, or if the veteran receives disability benefits. I’m grateful for all who have served or are serving. Thank you and may God bless you and the USA!
USDA
USDA loans are for areas identified by USDA as rural and boundaries are literally marked by specific streets. One side of a road may be eligible for USDA while the other side may not be. USDA does not require a down payment, but does require mortgage insurance for the life of the loan. The mortgage insurance is based on the loan amount at the beginning of each year at a rate of .35% annually. Because it is based on the remaining loan amount each year, the mortgage insurance for USDA is reduced a little each year as well. USDA does have a 1% guarantee fee, which is collected similarly to the FHA UFMIP.
How to Eliminate Mortgage Insurance
On a conventional loan, your mortgage insurance will automatically be removed once your LTV, based on the initial sales price of your home, reached 78% LTV. You can request for the mortgage insurance to be removed once your home reaches 80% LTV based on the current market conditions. However, and appraisal will likely be required and some additional paperwork. FHA will require you to refinance into a conventional loan once you are at 80% LTV in most cases. USDA will require you to refinance into a conventional loan as well. Again, with FHA and USDA, we will need to see where current rates are at to see if refinancing will make sense in your scenario.
Conclusion
Mortgage insurance costs vary in loan programs, LTV’s, and credit scores. It does not protect you from anything, but protects the lender from financial losses when a borrower defaults. Make sure to pay attention to mortgage insurance costs when shopping for a conventional mortgage as those costs will fluctuate from lender to lender. Shopping for a mortgage is not all about the interest rate and closing costs when mortgage insurance is needed on a conventional loan.
Most first-time homebuyers will need to pay for mortgage insurance when purchasing their first home so do not let it discourage you from purchasing a home. Do what you can to improve your credit scores and down payment amount and you will save money on mortgage insurance costs.
Well, that about wraps it up on the crash course on mortgage insurance! If you read through this, you likely now know more about mortgage insurance than your neighbors. Share this with your family and friends who may be getting ready to purchase a home. You might be the reason why they save money on their mortgage insurance!