by Shikma Rubin, NMLS # 1114873
Let me dispel one of the biggest myths in home buying: Mortgage insurance is something you must avoid at all cost. That is incorrect, and here is why. Mortgage insurance makes it possible to purchase a home even if one can’t make the traditional 20 percent down payment. The insurance allows one to keep more of his or her cash and achieve homeownership. Now that you understand why mortgage insurance plays a key role, let’s break it down on a more technical level. Mortgage insurance protects the lender for losses suffered if the borrower defaults on the payment. Mortgage insurance is typically included in a monthly mortgage payment. While conventional and FHA loans have mortgage insurance, they are structured differently.
On a conventional loan with private mortgage insurance (known as PMI), the lender automatically cancels PMI when the loan to value (LTV) reaches 78%, or 22% equity in the property. Loan to value means the amount borrowed in proportion to the original market value (based on appraisal at the time of purchase) of the property. Homeowners can petition to cancel the insurance by requesting a new appraisal if they believe they now have 20% equity in the property based on current market value (for example, renovations).
On an FHA loan, you have a mortgage insurance premium (MIP). That means FHA loans have a 0.85% (of the loan amount) monthly mortgage insurance. However, unlike conventional loans, MIP remains for the life of the loan. To cancel the premium, the borrower must refinance the loan and have 20% equity in the property. Here’s one more acronym for your alphabet soup: Lender Paid Mortgage Insurance (LPMI). On a conventional loan, LPMI is when the lender pays your mortgage insurance but charges you in a form of higher interest rate (usually an additional .25-.5%). To cancel any form of mortgage insurance, homeowners must be current on their mortgage payments.
“Mortgage insurance is a substitute for cash or equity,” said Dana Abernathy, the regional team leader with National MI. “The insurance allows a customer to buy a home at today’s rates versus waiting and saving 20%.” According to The Urban Institute, mortgage insurance providers are financially stable and even stronger in the wake of the housing crisis thanks to tighter risk management standards. As well, the insurance allows more people to qualify for homeownership.
Still, it’s important to understand what mortgage insurance won’t do. It won’t pay off the mortgage in the event the borrower dies, loses a job, becomes disabled, experiences a hazard of the disaster such as are or suffers fraud in the loan origination. The next time you hear the words “mortgage insurance,” don’t grimace at the thought of more insurance payments in your life. Think of the term as a way to become a homeowner sooner than thought possible.