Most loans with less than 20 percent down (for purchases) or home equity (for refinances) require some form of mortgage insurance. This can be pricey for some borrowers, so it’s important to have a strategy to deal with this type of insurance.
Everyone wants to pay less for mortgage insurance and with a little preparation and some shopping around that may be possible.
But before we look at lower costs, let’s first explain what mortgage insurance (MI or PMI for ‘private mortgage insurance’) really is.
I highly recommend that you read the entirety of Peter Miller’s post from The Mortgage Reports, although I’ve put together a few key pieces from his article below…and my article on Mortgage Insurance here…
For conventional (non-government) loans, it may be also be called PMI, or private mortgage insurance. FHA programs require mortgage insurance premiums (MIP) regardless of the size of down payment.
VA home loans call their insurance premium a funding fee. Some lenders may not require a separate insurance policy, but charge a higher interest rate to cover their risk.
Why 20 percent down?
Mortgage lenders really, really want you to buy a home with at least 20 percent down. That’s because it substantially reduces their losses if you don’t repay your loan and they have to foreclose.
However, most homebuyers, especially first-timers, don’t have 20 percent to purchase a property. The National Association of Realtors lists these figures for median down payments in 2018:
- All buyers: 13 percent
- First-time buyers: 7 percent
- Repeat buyers: 16 percent
If you don’t have 20 percent down, most lenders force you to purchase mortgage insurance. The policy covers their losses if you default and they don’t fully recover their costs in a foreclosure sale.
How much does mortgage insurance cost?
What MI costs are you likely to face? For conventional mortgages, MI costs depend on your credit rating, down payment size, and type of loan you choose. For government loans, your credit score does not affect mortgage insurance premiums.
Here’s the advice that Peter Miller gives on how to pay less….
How to pay less for mortgage insurance
Mortgage insurance can be a big cost. For example, if you buy a home for $250,000 with 3.5 percent down, and get FHA financing, the up-front MIP will be $4,222. You’ll also pay annual MIP of $171 per month. After five years, you will have spent $14,482 ($171 x 60 plus $4,222).
Here are several strategies to reduce or eliminate mortgage insurance costs.
Instead of getting one mortgage, get two. Try a first mortgage equal to 80 percent of the purchase price and a second mortgage for 5, 10 or 15 percent of the balance. You can then buy with no mortgage insurance. Here’s how that might work, assuming that you have a 700 FICO score, 5 percent down, and buy a traditional single-family home for $250,000:
- First mortgage principal and interest, assuming a 4.5 percent interest rate: $1,013.
- Second mortgage principal and interest, assuming a 7 percent interest rate: $249
- Total payment: $1,263
A comparable 95 percent loan with 25 percent coverage looks like this:
- First mortgage principal and interest at 4.5 percent: $1,203
- Mortgage insurance: $108
- Total payment: $1,311
In this case, the difference is about $50 a month.
If the value of your property has grown, you may be able to refinance to a loan without MI, instead of without waiting until your balance is less than 80 percent. When refinancing, you want to try for a double MI whammy — a new loan with both a lower rate and no MI requirement. Speak with a loan officer for details; the monthly savings might be significant.
Look for refundable premiums
If you expect to be a short-term owner, look for mortgage insurance programs with refundable premiums. With the FHA, for example, you can get a partial refund if you pay off the loan within three years. And private mortgage insurers also offer refundable premiums. However, their upfront costs may be higher.
Reduce your risk profile
With conventional financing, you can significantly reduce what you pay for mortgage insurance by being a less-risky borrower.
- Improve your credit score. Even a one-point increase can save you money if it puts you into a better tier
- Make a larger down payment. Going from 3 percent to 5 percent can save you money, depending on the program
- Choose a fixed loan over an ARM
- Choose a loan with a term of 20 years or fewer
Conventional loan guidelines allow borrowers to request cancellation of their MI once their loan falls to 80 percent of the value of the home when you took out your mortgage. You must normally be in good standing with your lender to drop MI this way.
With FHA and USDA mortgage insurance, coverage continues for the life of the loan. For VA-backed financing, there is no monthly charge.
Alternatively, mortgage insurance for conforming loans “must automatically terminate PMI on the date when your principal balance is scheduled to reach 78 percent of the original value of your home. For your PMI to be canceled on that date, you need to be current on your payments on the anticipated termination date. Otherwise, PMI will not be terminated until shortly after your payments are brought up to date.”
Do reach out to me to discuss your down payment and mortgage insurance options, as it would be my pleasure to help you!