February 28th, 2020 | mortgage
If you’re buying a home but don’t have a sizable down payment to invest, your best option may be a loan that charges mortgage insurance, such as an FHA or VA loan.
Since all lending is based on risk, there may be some cases where the lender wouldn’t want to approve a borrower for a mortgage without some guarantees or safeguards (or, they’d raise the rates/cost so high to account for that risk, it wouldn’t make sense).
That’s where Mortgage Insurance (MI) or Private Mortgage Insurance (PMI) come in. Most common with Federal Housing Administration (FHA)-backed home loans and others, mortgage insurance ensures that if the borrower stops making payments and defaults on the loan, the lender will still be indemnified.
That peace of mind allows the borrower to get a low interest rate at a fair price in situations where the lender may not be so willing to approve their mortgage without this financial assurance.
However, remember that mortgage insurance is there to protect the lender – not the consumers. Once the loan is funded and the ink dries, there’s no profound financial benefit to the borrower. In fact, homeowners will have to pay more every month as they write a check for their MI or PMI premiums.
FHA Loans and mortgage insurance
FHA loans mandate that borrowers pay mortgage insurance, both up-front when they close the loan and in the form of annual premiums. With FHA loans, that’s true for all borrowers – regardless of the loan amount, their credit scores, or the size of the down payment.
The up-front mortgage insurance cost for an FHA loan (called UPMIP) stands at 1.75% of the loan amount, which doesn’t change no matter how large the loan or how much money you put down. Taking out our calculators, that would mean a $300,000 FHA-backed loan would come with a $4,500 up-front cost to fund that mortgage insurance.
While that’s not an insignificant sum, the good news is that the UPMIP can be added to the loan amount instead of coming out-of-pocket when they close the loan.
In 2020, the Mortgage Insurance Premiums (MIP) for 30-year FHA loans range from 80 to 1.05 Basis Points, or bps. Since a basis point is just 1% of the loan amount, that means borrowers will pay between 0.80% to 1.05% of the loan amount per annum for mortgage insurance.
So, for a $300,000 loan at one basis point, you’d pay $3,000 annually for your MIP, prorated to $250 each month.
Generally, the more money you put down, the shorter your loan term (since there is far less risk in 15-year loans), and the lower the loan amount, the smaller your MI payments will be.
While FHA mortgage insurance isn’t necessarily a life sentence, the rules for removing MI are a little complex: If you funded your FHA loan before July 3rd, 2013, and put less than 10% down, you’ll have to pay MI for the life of the loan. In that same situation but you put more than 10% down, you can remove the mortgage insurance after 11 years. Borrowers used to be able to cancel their MI after they accrued enough equity so their loan-to-value (LTV) reached 78%, but that is no longer the case.
But you can refinance out of that FHA loan into a conventional loan or any other loan product that doesn’t come with mortgage insurance, which is the simplest option for most homeowners.
Veterans Affairs (VA) loans and mortgage insurance
If you’re eligible for a VA loan, you won’t have any mortgage insurance to pay, as Veterans Affairs (VA) guarantees those loans without MI. They do, however, charge a VA funding fee, a one-time fee that ensures against losses and keeps the program funded and healthy for military personnel and their families.
USDA loans and mortgage insurance
Likewise, USDA loans are government-backed mortgage loans that are geared towards helping people in rural and suburban areas buy homes with no down payment. But, unlike VA loans, USDA loans do come with mortgage insurance.
Mortgage insurance for USDA loans is paid in two ways: upfront and annually. The upfront mortgage insurance premium is 1% of the loan amount and is added to that loan, so borrowers don’t pay out-of-pocket at closing.
The annual fee for USDA loans adds up to 0.35% of the loan amount, which is significantly less expensive than similar premiums for FHA loan.
So, for a $300,000 loan funded with a USDA loan, the upfront mortgage insurance would be $3,000 (added to the loan), and the annual premium would come to only $1,050 per year.
Private Mortgage Insurance
When it comes to home loans with mortgage insurance, FHA, VA, and USDA aren’t the only options. Many conventional, non-government-backed loans will also come with mortgage insurance attached to the price tag, collectively referred to as Private Mortgage Insurance (PMI).
While there are far more options these days for borrowers and buyers who don’t have 20% to put down or 20% equity, PMI was once prevalent in the lending landscape. Just like mortgage insurance with FHA loans, the insurance is for the lender – not the borrower, ensuring that their loss will be covered in the event that you default on the loan.
Different banks, lenders, and loan programs are structured differently when it comes to how the mortgage insurance is funded and paid. Still, there most likely are monthly premiums and possibly an up-front fee, too, paid at closing.
Typically, when you accrue 20% equity (or pay your loan down below that threshold), there is a process where you can apply with the lender to have your PMI removed.
If you have any questions about qualifying for a loan with a low or no down payment, homeownership through FHA, VA or USDA loans, or mortgage insurance, please contact me!