What Is Mortgage Insurance?
You Pay for Private Mortgage Insurance But it Doesn't Insure You
There are several types of mortgage insurance, but the type that everybody complains about is private mortgage insurance. That's because homeowners with private mortgage insurance have to pay a hefty premium for an insurance policy, and it doesn't even cover them. Private mortgage insurance offers zero protection for the borrower.
Borrowers might think that private mortgage insurance makes them special, but there are no private services offered with this type of mortgage insurance.
You don't get a balcony suite overlooking the ocean.
A lesser known type of mortgage insurance is the type that pays off your mortgage in case you die. You pay a small premium for a small chance of dying. You probably could get better protection through a life insurance policy. The type of mortgage insurance most people carry is the type that insures the lender in the event the borrower stops paying the mortgage. That's right, private mortgage insurance insures your lender.
Why Do You Pay for Private Mortgage Insurance?
Many borrowers take out private mortgage insurance (PMI)because their lender requires it. The lender requires it because the borrower is putting down less than 20% of the sales price as a down payment. The less a borrower puts down, the higher the risk to the lender. So, the lender wants insurance against a default.
You don't choose the mortgage insurance company and you can't negotiate the premiums.
It sounds almost unAmerican, doesn't it? But that's the way it works when you get a mortgage that exceeds 80% loan-to-value.
If you put down 5%, for example, on a $200,000 home and stopped making your mortgage payments, mortgage insurance would pay your lender $30,000, which is the 15% that you did not put down to protect the lender to an 80% LTV.
This would happen after foreclosure.
FHA charges for mortgage insurance as well. Not only do you pay an upfront premium for mortgage insurance, but you pay a monthly premium, along with your principal, interest, insurance for property coverage and taxes.
How Do You Cancel Private Mortgage Insurance?
Once your equity rises above 20%, either through paying down your mortgage or appreciation, you might be eligible to stop paying PMI. The first step is to call your lender and ask how you can cancel your private mortgage insurance.
The lender will want proof that your equity position is secure and exceeds 20%. It will get that proof by requiring you to pay for an independent appraisal. You don't get a voice in choosing the appraiser or the amount that the appraisal will cost you, but it will probably cost between $350 and $500.
FHA rules are different. If you have an FHA loan, you will need to pay down your mortgage to 78% of your original sales price. Even if appreciation has pushed your equity up, it won't matter. You will need to reduce your original principal balance.
How Can You Avoid Paying for Private Mortgage Insurance?
There are many ways to avoid paying for private mortgage insurance.
You may not necessarily qualify for these nor want to do any of them.
- If you are a veteran, you can take out a VA loan, which has no private mortgage insurance.
- You can put down 20% or more as a down payment. Maybe you could tap the Bank of Mom and Dad?
- You can pay a higher interest rate. Sometimes the difference in your monthly payment spread out over your planned term of occupancy is much less than paying for mortgage insurance.
- You can take out a combination loan of 80 / 10 / 10. This consists of a 10% down payment, an 80% first mortgage and a 10% second mortgage.
- Look into a HomePath mortgage offered by Fannie Mae on select Fannie Mae bank-owned homes.
- Find out if your bank makes special loans to teachers or doctors as sometimes these types of financing do not demand private mortgage insurance. Of course, you will have to be a teacher or medical professional to qualify for these types of loans.
Realize that there is never a guarantee that your loan will not contain MI if your equity is less than 20% because lenders can pay for MI without your consent or knowledge.
At the time of writing, Elizabeth Weintraub, BRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.