Paying little bit more Mortgage Insurance is not always a bad thing!

Paying little bit more Mortgage Insurance is not always a bad thing!

First let me explain Mortgage insurance: 

       Mortgage Insurance takes many forms. It should not be confused with mortgage life insurance that pays the balance of their mortgage in the event of the borrower's death, and it should not be confused with homeowner or hazard insurance that pays for physical losses to the property and contents.

Private mortgage insurance (PMI) protects the mortgage lender if a homeowner defaults. PMI allows the lender recover some of its costs and losses after foreclosing and selling a repossessed home. PMI rates vary by loan type, loan size, and loan characteristics. The higher the risk to the bank, the higher the cost of PMI.

Following are two types of PMI:

1.        Borrower-paid mortgage insurance

2.        Lender-paid mortgage insurance

Borrower-paid mortgage insurance is the more common version of PMI.  It may be payable up front, payable monthly, or both.  However, once the mortgage balance is reduced to around 78% of the home's value, PMI may no longer be required by a lender.

Conventional Loans

Traditionally, borrowers made a 20% down payment when purchasing a home. That down payment was enough to provide the lender with sufficient equity in the event the borrowers defaulted on the loan. The lender would foreclose and the loss would be minimized by that equity.

However, since many people were not able to make a 20% down payment, lenders developed an alternate means of providing home ownership with a lower down payment: Mortgage Insurance. The mortgage insurer protected the lender against a portion of the loss in a defaulted mortgage, thereby reducing the lender's risk to an acceptable level. There are several private mortgage insurers in the industry. Although the lender usually coordinates the process of obtaining mortgage insurance. The borrower may select the mortgage insurer if desired. Mortgage insurance rates are regulated, however, so the lender's choice of an insurer should not have any impact on the premium.

FHA loans

The FHA (Federal Housing Administration) provides loans to borrowers with very low down payments. The concept is similar to conventional loans, with a few exceptions. The insurance dollars are paid to the FHA. An up-front premium is due at loan closing, and that premium may be included in the loan amount. A monthly insurance premium varies with the term of the loan and the loan-to-value ratio.

Well, now that you learn little bit about MI, I want to ask you a simple question:

Which one of these 2 types of loan gives you more buying power with 5% down? Can you afford to buy a higher price home with FHA or with Conventional?

If your answer is FHA, you must continue reading this blog!

Consider this: you can afford to pay $1745/month for your mortgage, we are going to see what price you can get for that monthly payment with FHA and Conventional (interest rate is 5%):

I calculated everything backward and this is the result.

           FHA:

            Max. Sale price is $289,790. Base Loan amount at 95% LTV is $275,300. Upfront FHA Premium is 1% so add $2,753 to Base loan so Gross Loan is $ 278,053, now P&I for 5% rate is $1,493 and monthly FHA MIP (1.10% rate) is $252. Total payment is going to be $252+$1493= $1,745

           Conventional:

            Max. Sale price is $335,620. Base Loan amount at 95% LTV is $318,839. Upfront MI rate is 1.95% so add $6,217 to Base loan to get to Gross Loan which is $325,056 now P&I for 5% rate is $1,745!

Yes, $45,830 more!

But remember you should have FICO of 760 and more. Don’t worry; average FICO score for FHA application was 715 last year!

My point is that paying little bit more Mortgage Insurance is not always a bad thing!