What you need to know about mortgage insurance
You'll be required to carry private mortgage insurance if you don't have enough cash to make a 20% down payment on a home.
It costs anywhere from 0.20% to 1.50% of the balance on your loan each year, based on your credit score, down payment and loan term.
The annual cost is divided into 12 monthly premiums and added to your monthly mortgage payment.
Mortgage insurance protects the lender, not you. If you fail to make the payments and must be foreclosed on, the mortgage insurer will cover a percentage of the lender’s loss.
That's why your mortgage servicer will insist that you continue that coverage until you've paid down the balance, and the property's appreciated enough, for you to have 20% to 25% equity in the home.
That means the balance on the mortgage has been reduced to at least 80% of the property's current market value.
Lenders know that borrowers are far less likely to default and create a major loss for the mortgage holder when they have a significant financial stake in the property.
It's not an uncommon requirement because many home buyers, especially first-time buyers, don't have the cash required for a 20% down payment.
In the fourth quarter of 2014, about 1 in 4 borrowers took out loans that required PMI according to Inside Mortgage Finance, a Bethesda, Maryland-based company providing residential mortgage statistics.
Which home buyers needed PMI?
|Generation||% who needed PMI|
|Millennials (ages 18-34)||43%|
|Gen X-ers (35-54)||37%|
|Baby Boomers (55+)||23%|
Source: 2014 TD Bank Mortgage Service Index
The great majority of those loans were made with down payments of 3% to 15%.
You'll often hear bankers or real estate agents refer to the loan-to-value ratio. That's the amount you're borrowing divided by the property’s market value.
If, for example, you make the absolute minimum down payment of 3%, then you'll move in with 3% equity, and your loan-to-value ratio will be 97%.
The minimum down payment is among the many rules set by the two government-controlled companies, Fannie Mae and Freddie Mac, that buy the great majority of mortgages.
Lenders who want to sell their loans to Fannie and Freddie must ensure that every loan meets or conforms to their minimum standards, which is where the term "conforming loans" comes from.
A conforming loan, or conventional loan as they're sometimes called, is not directly guaranteed by a federal agency.
That's what sets them apart from loans backed by the Federal Housing Administration and Department of Veterans Affairs.
Borrowers who can qualify for a VA loan can make no down payment and not be required to pay any form of mortgage insurance.
That's just one of the reasons we think VA loans are the best way to finance a home and encourage anyone who's eligible to consider them.
Home buyers with below average credit scores who can't qualify for a conforming loan can turn to FHA mortgages.
Financing is available for buyers with as little as 3.5% down, and earlier this year the government reduced the annual FHA mortgage insurance premiums from 1.35% to 0.85% of the outstanding balance.
Unfortunately, the Federal Housing Administration also requires a substantial up-front premium (1.75% of the amount you're borrowing) that private mortgage insurance does not.
Most home buyers using FHA-backed loans roll that premium into the amount they're financing, which pushes their principal and interest payments up by $8 to $10 a month for every $100,000 they're borrowing.
You'll also have to keep paying the annual premiums for the life of the loan. Unlike private mortgage insurance on conforming loans, you can't drop FHA mortgage insurance when your equity reaches 20% or 25%.
As a result, most borrowers will spend less with a conforming loan and PMI than with an FHA loan and FHA mortgage insurance.
But it never hurts to ask your lender to run the numbers for you and make sure.
The more you borrow and the lower your credit score, the higher your monthly PMI premium will be. The closer you get to 20% down and excellent credit, the lower the monthly PMI.
You’ll see some examples for a borrower with a credit score between 720 and 759 in the chart below. These numbers should be near universal, as all PMI companies typically charge the same or similar rates, which they update about once a year based on changes in borrower default rates.
How Much Would You Pay?
|Loan-to-Value||30-year fixed||15-year fixed||Monthly payment|
|90.01% to 95%||PMI 0.62% of loan||PMI 0.57% of loan||$52/$48 per $100,000 borrowed|
|85.01% to 90%||PMI 0.44% of loan||PMI 0.39% of loan||$37/$33 per $100,000 borrowed|
|85% and under||PMI 0.27% of loan||PMI 0.22% of loan||$23/$18 per $100,000 borrowed|
Once you've committed to paying PMI, you'll usually have to keep it for at least two years.
If your home has appreciated enough to give you 25% equity after two to five years, you can cancel the coverage. After five years, you just need 20% equity to ditch it.
In either scenario, you’ll need an appraisal, ordered directly by your lender, to substantiate your home’s value.
The federal Homeowners Protection Act requires lenders to cancel PMI automatically when you've reduced your balance to 78% of your home’s purchase price, even if its market value has declined since then. (This rule doesn’t apply if your loan was designated “high risk” when you took it out.)
With 10% down and a 30-year mortgage, it takes about seven years to reach that point if you only make the minimum monthly payments. One of the documents you received at closing should provide the exact date for your loan.
You should also receive an annual notice reminding you that you have PMI and that you have a right to request cancellation under certain conditions.
One thing to keep in mind: If you have a second mortgage, such as a home equity loan or home equity line of credit, that reduces your equity.
Say your home is worth $200,000, and you owe $140,000 on your first mortgage. That gives you 30% equity, or $60,000.
But if you had a second mortgage for $30,000, your equity would drop to 15%, making you ineligible to cancel PMI.
PMI has been tax-deductible since 2007, but no one knows whether the tax break will apply to mortgage insurance premiums paid in 2015. Congress will probably decide at the end of 2015 or the beginning of 2016.
That deduction is one of a few dozen tax provisions that keeps expiring each year and getting extended for one more year at the last second. Don’t count on it, but consider it a bonus if you end up being able to claim it.
PMI is only tax-deductible if you took out your loan in 2007 or later and you itemize your deductions using Schedule A.
The deduction phases out when your household’s adjusted gross income — that’s your income before any deductions — reaches $100,000, whether you’re married filing jointly or single. At $109,000, you can’t claim the deduction at all.