What is Mortgage Insurance
A few days ago, a first time home buyer asked me, 'How many insurance policies do we have'? It really is a bit confusing when you start looking at the additional monthly costs of obtaining a loan.
There are two insurance policies you need when financing a home. The first is your standard homeowners policy, which covers the structure and personal property against loss. The second is property mortgage insurance. Actually three, including Title Insurance. In Indiana, the owners title policy is almost always paid for by the seller, though and is a one time fee. Title Insurance is another post.
Why Would I Pay Mortgage Insurance?
Mortgage Insurance allows home buyers to buy a home without having 20% down. I know it seems like a lot of money, but let's consider the alternatives. If you had the choice to lease or buy a home today and had enough money for down payment and closing costs for an FHA loan, your monthly payment would most likely be less than the cost to lease, while you are building equity in your home.
Okay, I know equity is a bit overated right now. However, real estate in Indianapolis today is the best we have seen for home buyers in a long time. If you were financing $100,000., your monthly payment at today's rates for an FHA loan would be approximately $720.00.*
How Mortgage Insurance Affects Your Monthly Payment
Mortgage Insurance Premium (MIP) for a FHA loan or Private Mortgage Insurance (PMI) on a conventional mortgage is generally required when the borrower has less than 20% down payment. Both are a lender fee for an insurance policy which protects the lender from loss if the home owner should default on their loan. Mortgage insurance premiums are calculated by risk based pricing. They take into account the percentage of the purchase price you are financing, as well as your credit score.
Typically, rates range from .5% to 1.5% of the loan balance. If you have a $100,000. loan balance at .5%, you would calculate your mortgage insurance by multiplying $100,000 x .5 , which equals $500.00. Divide $500.00 by 12 and your monthly PMI payment would be $41.67 a month. FHA MIP is currently at 1.15%, which equals about $96.00 a month on a $100,000 loan amount, plus an an upfront fee of 1% of the loan amount. As you pay down your principal balance, the monthly amount of mortgage insurance also reduces.
How Long do I Have to Pay Mortgage Insurance?
In most cases, the mortgage insurance premium will fall off after you have paid your loan down to 78% of the original purchase price. Many lenders have stipulations that require you must have been timely in your payments for the last 12 - 24 months before requesting the removal of mortgage insurance premiums.
The Homeowners Protection Act of 1998 spells out specific guidelines to lenders for the removal of mortgage insurance premiums. Mortgage insurance must be removed once you have 80% equity with the following guidelines:
- You make a written request
- Provide an appraisal stating the property has not declined in value
- The property is not encumbered by a second lien
- You have a good payment history
A lender MUST remove mortgage insurance premiums when the the home owner has 78% equity under the following guidelines:
- The loan to value reaches 78%
- You have to be current on your payments.
- The lender can NOT evaluate whether the property has depreciated.
The lender MUST remove PMI at the midpoint of your original loan, regardless of whether you have 78% loan to value ratio. This does not apply if you reffinance your original loan.
Obviously, the sooner you can get rid of mortgage premiums, the better. Under the 80% loan to value ratio, you could not have had any payments more than 60 days late in the last two years or 30 days late in the previous 12 months before asking for removal of mortgage insurance.
You can also remove property mortgage insurance if you make extra payments toward your equity, resulting in a 80% loan to value ratio. You would fall under the first guidelines. On an FHA loan, you can not cancel mortgage insurance premiums until after five years, regardless of the amount of equity accrued.
*Monthly payment assumes a principal, interest @ 4.04% APR on $100,000.00.and include taxes, insurance and PMI.