What is mortgage insurance and why do I need it?
For years, everyone that has ever thought about purchasing or refinancing a home has had this question and gone to great lengths to avoid the “monster” called mortgage insurance, or, sometimes referred to as PMI (private mortgage insurance). However, in today’s housing market where we have all experienced declining home values, mortgage insurance has become commonplace and necessary to allow homeowners and potential homeowners to obtain financing for a new home or refinance their existing loan with the very low interest rates that are being currently offered. Mortgage insurance is a default insurance for the lender, and unfortunately, the lender passes this charge on to the homeowner. Standard lending guidelines dictate that a lender’s maximum exposure in any loan cannot be more than 80%. With mortgage insurance placed on the loan, the lender is protected and thus, is willing to lend as much as 100% of the market value or purchase price of the home, depending on the specific loan product. The lender is willing to go the higher loan to value on the home because the mortgage insurance provider pays any loss to the lender in excess of 80% of the home’s value. There are multiple options for homeowners today in the mortgage insurance market so let’s take a look at the basic types offered and the types of loans these options are combined with:
Conventional Financing: Conventional financing requires mortgage insurance for any loan amount that exceeds 80% of the current fair market value of your home or the purchase price of a home, whichever is less. There are 2 types of conventional mortgage insurance. The first type, and, until recently, the most common is monthly mortgage insurance. The cost of the mortgage insurance is calculated according to how much over the standard 80% loan to value you are borrowing. The cost increases in 5% loan to value increments (meaning there is a scale for 80-85%, a scale for 85.01-90%, and so on). The cost is calculated and there is an additional monthly premium for the mortgage insurance added to your monthly mortgage payment. The second type, and one that is increasing in popularity is the single-premium mortgage insurance policy. This type of coverage is also based on a 5% increment scale similar to the monthly mortgage insurance. However, the cost of this type coverage is paid all at once (by either adding it to your loan amount or you paying it all up front). The single premium mortgage insurance is gaining popularity because it always results in a lower total monthly payment to the homeowner. However, you want to review both options for the type that is going to work best for you. If you are going to be in the home for a short period of time (say 1-3 years), you may be better off paying the monthly premium versus the one-time premium. Simply add up the amount you will spend monthly until the time you sell or refinance and compare it to the cost of the single premium and see which is better for your situation. Your mortgage lender can assist you in this comparison. The monthly premium option will automatically drop off of your payment when the principal balance of your loan reaches 78% of the original amount borrowed.
Government Financing: Mortgage insurance is required on all FHA insured loans. The major difference between the FHA mortgage insurance and conventional mortgage insurance is FHA requires both an up- front charge of 1% of the amount you are borrowing, as well as a monthly charge added to your payment. The amount of the charge also depends on the loan to value as well as the number of years you are financing the home for. The monthly charge for FHA mortgage insurance automatically drops off of your monthly payment when the loan amount reaches 78% of the original amount borrowed.
While I am not, and should not be considered a tax advisor by any means, there have been tax deductibility changes for mortgage insurance in recent years that were not available in the past. Basically, if your adjusted gross income is less than $ 100,000 per year, a portion, if not all, of the mortgage insurance you pay could be tax deductible. In the past, this was not the case. Consult your tax advisor for the tax guidelines and rules for this deductibility.
In theory, no one wants to pay mortgage insurance, but it does give all homeowners additional flexibility and the availability of mortgage borrowing in excess of 80% of the value of your home. FHA mortgage insurance also opens up financing options and gives homeowners who have less than stellar credit the opportunity to become a homeowner or refinance their existing home at much better rates and terms. Use it to your advantage, but be sure to take the time to have all of the different types of mortgage insurance available explained to you and make your lender show you in writing a comparison between them so you can pick the option that works best for you and your family.
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