Topic 11 - Understanding Mortgage Insurance
Topic 11 - Understanding Mortgage Insurance
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Mortgage Insurance covers the mortgage lender against loss caused by a mortgagor's default. It may cover all or part of the loss and it may or may not relieve any liability on the borrowers part if default on the mortgage occurs.
Private Mortgage Insurance (PMI) is a conventional lending policy developed to help borrowers purchase a home without putting 20% down as was required by banks and lenders many years ago. I like to think of it as a "hired co-borrower". Two out of five borrowers use PMI to get into home years sooner than they would otherwise. In fact, in the past 40 years PMI has helped make home-ownership a reality for more than 19 million families. Different types of loans refer to it in different ways, and some loans have different requirements for the amount of coverage needed, but it essentially serves the same purpose. It helps protect the lender.
Not all loans require mortgage insurance and the premium varies due to different criteria Conventional Mortgages. Mortgage loans that are traditionally, referred to as "government loans" are either insured by the Federal Housing Administration or guaranteed by the Veterans Administration for eligible veterans. In still, other scenarios a "Lender Paid Mortgage Insurance" may be employed where the mortgage insurance premium is included in the lender's interest charges. When the loan to value for an owner–occupied residence is more than 80% (or the borrower is putting less than 20% down) then some type of Mortgage Insurance (or PMI), is typically required. The premium may be paid on an annual, monthly or single premium plan. (The most popular method of payment is the monthly method). The premiums are based on the amount and terms of the loan and may vary according to the loan-to-value, type of loan, term of loan and the amount of coverage required by the lender. The less the borrower puts down the higher the premium. PMI may be waived when the loan reaches 80% or less of the value of the property. Further details on the differences in mortgage insurance options are revealed below.
Private Mortgage Insurance
Private Mortgage Insurance (PMI) is a mortgage insurance policy written by a private company like MGIC, PMI, GE or Radian. These companies insures repayment of the loan balance to the lender in the event of default by the borrower. PMI is traditionally, more restrictive than government-related options for high-ltv loans on borrower quality. Since these providers are seeking the higher-qualified borrower to insure, their premiums are generally, more attractive to consumers who must pick the best of two evils. Calculating a PMI policy might translate into a scenario like this:
|Sales Price/Value: |$100,000 |
|Down payment: |$5,000 |
|Loan Amount: |$95,000 |
|Monthly PMI Payment: | |
| |$61.75 (Formula: $95,000 * .78% = $741 / 12 Months) |
PMI policies typically, require little or no up-front costs to the borrower which is another reason they might be considered more attractive. A number of options are available to the PMI-eligible borrower which you can further review by downloading MGIC's current rate card here in .pdf format:
MGIC Rate Card Download
VA Mortgages
A VA loan is guaranteed by the Veterans Administration (VA) and the lender is required to collect an up-front one-time fee at closing called the "Funding Fee". This amount is between .50% and 3.00% of the loan amount depending upon the status of the Veteran and if the Veteran has used his VA Benefits previously to purchase a home. There is no monthly premium and there is no refund of the Funding Fee when the loan–to-value is reduced below 80% or if the loan is paid off early. A VA-eligible borrower (unless they are disabled) can typically, expect a "funding fee" of 2% to be added to their loan balance like this:
|Sales Price/Value: |$100,000 |
|Down payment: |$0 |
|Loan Amount: |$100,000 |
|Loan Amount + VA Funding Fee | |
| |$102,000 (Formula: $100,000 + 2% = $102,000) |
FHA Mortgages
Regardless of the amount of the down payment, FHA requires a one time upfront fee of 1.5% (this may vary from time to time) of the loan amount which may be financed in with the loan. In addition to the upfront fee there is a yearly fee of .50% of the unpaid balance of the loan which is divided into 12 equal payments and paid monthly in the house payment. If the loan is paid in full within the first 7 years there may be a prorated refund of the upfront premium paid. The monthly mortgage insurance premium may not be waived regardless of the loan to value. An FHA mortgage insurance premium could be figured as follows:
|Sales Price/Value: |$100,000 |
|Down payment: |$3,000 |
|Loan Amount: |$97,000 |
|Loan Amount with MIP Financed: | |
| |$98,455 (Formula: $97,000 * 1.5% = $98,455) |
|Supplemental Monthly Payment: | |
| |$40.41 (Formula: $97,000 * .50% = $485 / 12 Months) |
Lender Paid Mortgage Insurance
Another type of mortgage insurance you may or may not hear about is "Lender Paid Mortgage Insurance". It is also referred to as "self-insuring" in some situations. That is perhaps, a more accurate description of this mortgage insuring method as lenders simply charge the borrower a slightly, higher interest rate to compensate for the lender's cost of a separate PMI policy. In some situations, this has been advantageous for borrowers in that the lender was probably able to get a reduced premium with the mortgage insurer and some of that savings was past on to the borrower in lower total finance costs. The use of the term "Lender Paid Mortgage Insurance" actually became more popular then "self-insured" because it sounds better to the borrower who is being sold on it. An agreement for a note-rate increase to cover PMI costs is normally, not something that the lender has to drop at 80% LTV as in most PMI related scenarios, which might make it more advantageous for a lender who services the loan. This twist then, leads us to the next issue of legal wrangling.
Legislation in recent years has amended how lenders can collect for mortgage insurance charges and has eliminated the large "slush-funds" of unnecessarily, held proceeds for risk after the borrower has reached 20% equity. Perhaps the most infamous of these is the "Homeowner's Protection Act".
Homeowners Protection Act
A federal law, called the Homeowners Protection Act, affects many loans originated after July 29, 1999. The law ensures that PMI will be cancelled when an homeowner has reached a certain level of equity in their home. This means two things to the homeowner: The lender must inform the borrower, both at the time of closing and annually, about their right to request the cancellation of PMI. The lender may be required to automatically cancel PMI at a certain point if the borrower has not already requested that it be dropped.
Other provisions of the Homeowners Protection Act you should advise the borrower of are as follows:
Initial Disclosure
At closing, the lender must provide the borrower with written notification explaining that you have PMI on your loan and how it may be cancelled.
Annual Disclosure
Each year, the lender must send the borrower a reminder that they have PMI and may request cancellation once they have met certain requirements
Borrower Initiated Cancellation
When the mortgage balance reaches 80% of the home's original value, the lender must cancel the PMI at the borrower’s request if the mortgage payments are current, they have no other loans on the house and satisfy any lender requirements confirming that the property value has not declined.
Automatic Termination
When the mortgage balance reaches 78% of the home's original value, the lender will automatically cancel the PMI if the borrower is current on their mortgage payments. Note: If the mortgage is classified as a "High-Risk" mortgage, certain other conditions may apply.
Does This Law Apply to FHA or VA Mortgages?
No. Mortgage insurance on FHA loans cannot be cancelled and must be paid for the life of the loan. VA loans don't have PMI. It is called a "Funding Fee" and is paid or financed at closing and is a non-refundable one-time fee.
The power-point presentations under this topic will better prepare you for the questions that borrowers commonly ask about mortgage-insurance.
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