So there you are, ready to buy and have a down payment saved up. You do some reading and find out you will need mortgage insurance (PMI). You may hear from people in your corner to avoid mortgage insurance. Sure, if you are putting down 10-20% you certainly may be able to avoid the mortgage insurance requirements. Mind you with 10% down you will need a credit score over 700 and a lender who structures your loan to alleviate the mortgage insurance requirements from your payment. But before assuming the worst, let’s understand what the requirements are to carry mortgage insurance. I will break this down by FHA and conventional mortgages for this article.
First, FHA has mortgage insurance issued by HUD (Dept. of Housing and Urban Development). What this does is allow you to put down as little as 3.5% and obtain an interest rate that is lower than conventional mortgage rates. With FHA mortgages, unless you put 10% down on the house, or have that in equity on a refinance, then the mortgage insurance will be on the loan as long as you have the mortgage. The amount of mortgage insurance is fixed (%) based on your loan amount and whether you put <5% or >5% down on the house.
With conventional mortgages it is not as straight forward. It starts with your credit score. So the higher the score the cheaper your mortgage insurance will be. From there, it depends on your down payment (or equity on refinance). So 3% down (equity) requires the most expensive coverage. From there, there are cost breaks at 5%, 10%, 15%, and the magical 20% mark. For every step closer to 20% down (equity) you have less coverage required, so it is cheaper. But again, that is also tied back to your credit score to determine monthly costs for the mortgage insurance requirement you carry. From there, you can potentially use different strategies to reduce the mortgage insurance or buy it out completely. However, this strategy applies to conventional mortgages only.
After closing on the loan the mortgage insurance will stay in place. You pay it as a part of your total monthly payment. The reason? If you put less money down, the servicer is exposed should you default. So this is paid to protect them in the off chance you default. Should that happen the servicer would make a claim for the loss to either HUD (FHA) or the PMI company (conventional) to recoup their losses on the defaulted mortgage. However, PMI/MMI allows you to put less money down and buy the house. So it is a trade-off.
An interesting comment I hear commonly is that conventional mortgages are better because FHA mortgage insurance is required as long as you have the (FHA) loan in place. Fair, but let’s break this apart. Fannie Mae’s statistics show currently the average life of a mortgage is 37-48 months. So let’s face it, if you put 5% down with a conventional mortgage and live up to statistics you too will have mortgage insurance the whole time you carry that mortgage. So how is that different than FHA mortgage insurance requirements? One thing that is different is that with a conventional mortgage after closing if you reach 78% (not 80%) loan to value your mortgage insurance will be removed, should it be your primary residence. It can be a combination of appreciation in your home (change in value) and principal reduction (payments). That won’t happen over night, and you may not own the house or still have the same mortgage this many years down the road.
All in all mortgage insurance is required under certain circumstances with your mortgage. To determine what loan program is right for you, should not just be based on the mortgage insurance conversation. We’ll get to that in future blogs. But it is all about structure and strategy.
Branch Manager, Mortgage Maestro Group @ Summit Mortgage