Is PMI Required for All Conventional Mortgages?
Did you know that the seller can pay your private mortgage insurance (PMI?
Conventional
home loans underwritten to the lending guidelines (rules) of
the Federal Home Loan Corporation (aka Freddie Mac) and the
Federal National Mortgage Association (also known as Fannie
Mae) require a 20% down payment.
But of course, most borrowers are unable to provide a 20%
down payment. Fannie Mae and Freddie Mac need the 20% equity
as a buffer in the event of a foreclosure. If the borrower
defaults on the loan, the property can be sold for 20% below
the home's value.
Private mortgage insurance (PMI) companies pay the lender
the difference between your down payment and the required
20% down payment if you default on the loan.
For example, if your down payment is 5%, the PMI company
will pay the lender 15% of the sales price if you default on
the mortgage. Between your 5% and the PMI company's of 15%,
the lender has 20% equity in the property and a cushion if
there is a foreclosure.
The cost of the private mortgage insurance is paid by the
borrower of course. There are four payment options with
private mortgage insurance. The PMI cost takes into
consideration an applicant's credit score, down payment
amount, several other variables.
- Borrower-paid mortgage insurance (monthly)
- Single-premium mortgage insurance
- Split-premium mortgage insurance
- Lender-paid mortgage insurance
Borrower-paid mortgage insurance (monthly)
Without question, the most popular payment plan is the monthly mortgage insurance option. Probably because it's the easiest for the loan officer. The PMI premium is billed annually and the lender collects 1/12 of the annual premium and includes the cost with the mortgage payment.
Single-premium mortgage insurance
Rather than splitting the PMI payments into monthly
installments, single-premium PMI combines the full cost of
the insurance into a single payment.
You can either pay the full amount at closing or roll the
amount into the loan for a higher loan balance, depending on
the loan terms. This option can be used in conjunction with
seller paid assistance.
Split-premium mortgage insurance
The split-premium mortgage insurance blends the monthly mortgage insurance premium with the single-premium mortgage insurance. There is an upfront payment at closing and a reduced monthly payment.
Lender-paid mortgage insurance
The lender-paid mortgage insurance reminds me of the
shell game. With lender paid mortgage insurance, you agree
to a higher interest rate in exchange for removing the
private mortgage insurance altogether.
Here's a comparison between the 4 PMI
options:
The following example assumes a credit score of 680 with a
down payment of 10%:
Monthly - $108.33
Split-premium mortgage insurance - $2,000 (1%) paid at
settlement & $78 monthly
Single-premium mortgage insurance - $3,317
Lender-paid mortgage insurance - Mortgage payment increases
by $83
There is one more option. A bit confusing, so I won't get
into a long explanation, but it involves using a second
mortgage to off set the private mortgage insurance expense.
This option is usually called a piggy back loan, because the
2nd mortgage piggybacks the 1st mortgage.
Using the previous example, the
sales price is $222,222
less $22,222 (10% down payment)
2nd mortgage 22,222 @8% = $146 monthly
The 2nd mortgage can be a fixed rate, or an adjustable
interest rate.
When does private mortgage insurance end?
The
federal Homeowners Protection Act (HPA) allows for the
elimination of Private Mortgage Insurance (PMI).
Generally, the law offers two methods for removing PMI
from a house loan:
(1) seeking PMI cancellation; or
(2) terminating PMI automatically or permanently.
Request cancellation of PMI
If the outstanding balance of your mortgage is less
than 80% of the home's original value, you have the
right to request that your servicer cancel the private
mortgage insurance. This cancellation date should have
been disclosed to you in writing during the mortgage
application, with the PMI disclosure form. Contact your
service provider if you can't find the disclosure form.
You may be eligible for PMI cancellation sooner, if you
have made additional payments that reduce the principal
balance of your mortgage to 80 percent of the home's
original value.
The term "original value" refers to the lesser of the
contract sales price or the appraised value of the
property at the time of purchase (or, if you have
refinanced, the appraised value at the time you
refinanced).
Additional conditions must be satisfied if you want to
eliminate the PMI on your loan:
- If the value of your property has fallen below the initial purchase price, you may be unable to cancel PMI at this time.
- You must have a positive payment history and maintain current payments.
- You must submit your request in writing.
- Your lender may ask you to produce proof (such as an appraisal) that the value of your property has not decreased below the home's original worth.
- Your lender may ask you to confirm that there are no junior liens on your property (such as a second mortgage).
Termination of PMI automatically
Even if you do not request
that your servicer discontinue PMI, your servicer is
required to do so automatically when your principal
amount reaches 78 percent of the home's original value.
To ensure that your PMI is terminated on that date, you
must be current on your payments at the time of the
expected termination. Otherwise, PMI will remain in
effect until your payments are brought current.
SOURCE: Consumer Financial Protection Bureau
Conclusion
In conclusion, whether or not PMI is required for a conventional mortgage depends on a variety of factors. It is important to speak with a qualified mortgage professional to determine if PMI is necessary for your specific situation.