This article was inspired by reading Richard Smith's post this morning Mortgage Insurance Companies-Losses Increase Concern. I thought I would take the opportunity to clarify what Mortgage Insurance is.
There is a lot of confusion when I am asked about Mortgage Insurance. Does it cover me if I lose my job? Is it protection for me if I become disabled? Does it cover my payment? Is it like my hazard insurance policy? How does it work? Is the lender providing my insurance?
Mortgage Insurance is insurance coverage for the lender on a mortgage with less than a 20% down payment. Insurance for the lender? Why am I providing insurance for the lender? Here is how it works. The lender has agreed to give you a loan. You have great credit, a good job, have found your perfect home-except you do not have a 20% down payment. Typically, this is what the mortgage industry has found to be a reasonable amount to show the buyer is "invested" in the property. Studies have shown that buyers with a 20% cash investment in a property are less likely to result in foreclosure and risk the loss of their 20% investment of their own funds.
BUT THAT'S NOT FAIR! I have worked really hard to get where I am and have saved enough for 5% down! I still should be able to get a loan! You are right! And the lenders agree! However, in order for the lender to feel like their investment in making the loan is protected, they are going to require you provide them with "insurance" that will protect them from a loss between the 80% Loan to Value ratio (where they feel comfortable lending) and the 95% Loan to Value ratio (you can afford!).
This is where Mortgage Insurance comes in. Based on the loan to value (LTV) of the loan being obtained, the lender will require insurance coverage to cover themselves in case of a loss due to foreclosure. The lender is willing to go to 80% LTV and then the Private Mortgage Insurersays ok, these people are a good risk based on all of the guidelines we have set up, we will cover the difference. (From 80.01% to 97% LTV) Any loss the lender would take in the event of foreclosure for this difference (16.9% variance) is covered by Mortgage Insurance.
The premiums for Mortgage Insuranceare based on a percentage of the loan amount and are set by the insurance company. The percentage is based on the LTV, underwriting guidelines, FICO scores and the amount of risk they are covering. The percentage can range anywhere from .5% to 1.64% of the loan amount. Example: $100,000 purchase with 5% down payment gives us a loan of $95,000 and a 95% LTV. The Mortgage Insurance for this loan assuming a factor of 1.06% would be an annual premium of $1007 with monthly payments of $83.92. This amount would be included with your monthly principal and interest payment, taxes and insurance and would constitute your total mortgage payment for the loan.
Are PMI and MIP the same thing? The difference between PMI and MIP is who the insurance carrier is. PMI stands for Private Mortgage Insuranceand is offered by privately owned companies for the lenders insurance on a conventional loan. MIP stands for Mortgage Insurance Premium and is used when describing the Mortgage Insurance on an FHA loan. They work the same; they both provide the lender with insurance against loss in the event of a foreclosure.
Is Mortgage Insurance tax deductible? Depending upon your household income, all or a portion of borrower paid Mortgage Insurance is tax deductible through the year 2010. Your CPA or tax preparer should be able to assist you with the income limitations.
Can I cancel Mortgage Insurance? The buyer can not cancel with the Mortgage Insurance company directly. The lender is the one collecting the payments and paying the premium directly to the Mortgage Insurance company and they are the only ones with the ability to cancel the policy. You can request cancellation of Mortgage Insurance through your lender if the equity in your home is below 80% loan to value, you are making your payments on time and have the loan for over one year. The lender may require there be an appraisal done on the property to confirm the LTV is below 80%. As long as this is determined, the Mortgage Insurancewill be canceled. Any loan made today with Mortgage Insuranceis required to automatically cancel the Mortgage Insurance once the LTV has reached 78% of the original value of the property at the time the loan was made. This cancellation applies to both conventional and FHA loans.
So, what is the benefit of Mortgage Insurance? It enables you, the buyer the opportunity to own a home with less than 20% down. It provides insurance to the lender to make them feel warm and fuzzy about giving you a loan with less than 20% down by providing coverage for any loss above the 80%. It is not for the life of the loan and all or a portion may be tax deductible (for at least another year!) Not such a bad deal! Here you thought you would have to wait. Go find the home of your dreams! Happy House Hunting!