PMI mistakes to avoid: how to pay less for mortgage insurance

What is Mortgage Loan Insurance (MA)?

Everyone wants to pay less for Mortgage Loan Insurance (MI), and with a little preparation and a little shopping, it can be possible. But before we look at the lower costs, let’s first explain what MI really is.

Most loans with less than 20% down payment (for purchases) or home equity (for refinances) require some form of mortgage insurance. For conventional (non-government) loans, it can also be referred to as PMI or private mortgage insurance. FHA programs require mortgage insurance premiums (MIP) regardless of the size of the down payment. VA home loans call their insurance premium a finance charge. Some lenders may not require a separate insurance policy, but charge a higher interest rate to cover their risk.

Find the rates for programs with and without mortgage insurance (June 14, 2021)

Why 20% less?

Mortgage lenders really, really want you to buy a home with at least 20 percent down. This is because it greatly reduces their losses if you don’t pay off your loan and they have to foreclose.

However, most homebuyers, especially first-time buyers, don’t have 20% to buy a property. The National Association of Realtors lists these numbers for median down payments in 2018:

• All buyers: 13%
• first-time buyers: 7%
• Regular buyers: 16%

If you don’t have a 20% down payment, most lenders require you to purchase mortgage insurance. The policy covers their losses if you default and they don’t fully recoup their costs in a foreclosure sale.

How much does mortgage insurance cost?

What MI costs are you likely to face? For conventional mortgages, IM’s fees depend on your credit rating, the amount of down payment and the type of loan you choose. For government loans, your credit rating does not affect mortgage insurance premiums.

Related: Avoiding PMI Costs You $ 13,000 Per Year

Conventional loans (non-governmental)

Mortgage insurance costs for conventional loans can vary widely. Unlike government mortgages, mortgage insurance costs for conventional mortgages can largely depend on your credit rating.

Compliant mortgages

Mortgages that meet Fannie Mae and Freddie Mac standards – known as “Compliant Mortgages” – are available with a down payment of only 3-5%. Lenders can choose the level of coverage they want for these loans.

The graph below shows the rates set by a national insurer. Note that they depend on the borrower’s credit rating, loan-to-value ratio, and loan type. Those with higher scores pay less. Borrowers who choose fixed rate mortgages pay less. And the same goes for those who have 15 year loans instead of 30 year loans. Insurers also adjust the type of property (condo, multi-unit, second home, etc.) and other factors.

You would think that since 20% down payment is needed to avoid mortgage insurance, lenders would only need enough coverage to reach 20% – that if you put 5% down payment, they would only need 15% coverage.

But in most cases you are wrong: Lenders tend to choose more coverage and less exposure. This is because your chances of default increase as your down payment decreases. So if you put in 5 percent, you will probably have to pay 25 percent coverage. And your premium for a 30-year fixed loan can range from 0.34% to 1.25%, depending on your credit score.

Non-compliant portfolio or loans

Non-conforming mortgages are mortgages that do not meet conforming lending guidelines. This could be due to their size (large loans can also be referred to as jumbo loans) or other factors. Investors can buy them, but not through Fannie Mae or Freddie Mac.

Mortgage loan insurance can be a problem for those with non-conforming home loans.

Portfolio loans are mortgages that the lender keeps on their own books and does not sell. Portfolio lenders are more likely to self-insure. This means that they can charge a higher interest rate to cover the additional risk of default with a lower down payment.

Government loans

Government mortgages also require insurance. But the factors that determine your costs are not as variable as with conventional mortgages.

FHA Mortgages

You can buy with as little as 3.5% off under the FHA program. With an FHA guaranteed loan, you pay two types of mortgage insurance premiums (MIPs). First, there is an initial MIP fee equal to 1.75% of the mortgage amount. You can choose to add this amount to the mortgage if you don’t want to pay it out of pocket on closing. You will also pay an annual premium (divided by 12 and added to your monthly payment) which depends on the amount and the duration of your loan.

The premiums for FHA loans vary between 0.80% and 1.05%, depending on your loan amount and the down payment. The rates for 15-year loans range from 0.45% to 0.95%. You pay these premiums for the life of the loan.

VA real estate loans

VA qualified buyers can purchase without any down payment. There is an upfront finance charge but no monthly insurance charge.

Funding costs depend on your down payment and whether you have used the program before. It may be exempt for disabled borrowers.

The table below shows how the VA financing fees are determined.

Type of military service	Advance payment	Fee for first use	Fee for later use
Active service, reserves and national guard	Nothing	2.3%	3.6%
	5% or more	1.65%	1.65%
	10% or more	1.4%	1.4%

USDA funding

With USDA funding, there is an upfront fee of 1% as well as an annual fee of 0.35%. Payments continue for the life of the loan.

How to pay less for your mortgage insurance

Mortgage loan insurance can be very expensive. For example, if you buy a home for $ 250,000 with a 3.5% down payment and get FHA financing, the initial PIM will be $ 4,222. You will also pay an annual MIP of $ 171 per month. After five years, you will have spent $ 14,482 ($ 171 x 60 plus $ 4,222).

Here are several strategies for reducing or eliminating mortgage insurance costs.

Go on the back

Instead of getting a mortgage, get two. Try a first mortgage equal to 80 percent of the purchase price and a second mortgage for 5, 10, or 15 percent of the balance. You can then buy without mortgage insurance. Here’s how it might work, assuming you have a 700.5% lower FICO score, and buy a traditional single-family home for $ 250,000:

• Principal and interest on first mortgage, assuming 4.5% interest rate: $ 1,013.
• Principal and interest of the second mortgage, assuming an interest rate of 7%: $ 249
• Total payment: $ 1,263

A comparable 95% loan with 25% coverage looks like this:

• Principal and interest on the first mortgage at 4.5%: $ 1,203
• Mortgage insurance: $ 108
• Total payment: $ 1,311

In this case, the difference is around $ 50 per month.

Refinance

If the value of your property has increased, you may be able to refinance a loan without MI, instead of waiting until your balance is below 80%. When refinancing, you want to try a double MI hit – a new loan with both a lower rate and no MI requirement. Speak to a loan officer for more details; monthly savings could be significant.

Look for refundable premiums

If you plan on owning a home for the short term, look for mortgage insurance programs with refundable premiums. With the FHA, for example, you can get a partial repayment if you pay off the loan within three years. And private mortgage insurers also offer refundable premiums. However, their initial costs may be higher.

Reduce your risk profile

With conventional financing, you can significantly reduce what you pay for mortgage insurance by being a less risky borrower.

• Improve your credit score. Even a one point increase can save you money if it puts you in a better tier.
• Make a larger down payment. Going from 3% to 5% can save you money, depending on the program
• Choose a fixed loan rather than an ARM
• Choose a loan with a term of 20 years or less

Choose the right program

For those with small down payments, VA home loans are almost always the cheapest. Interest rates are generally lower than conventional rates because the government is backing the loan. You can include the financing costs in the loan or have the seller pay them when you buy a home. And there is no monthly premium. However, you must be eligible for the VA.

Borrowers with good to excellent credit will almost always pay less for private mortgage insurance than for FHA coverage. And FHA mortgage insurance never goes away no matter how low your loan balance gets. However, home buyers with low credit scores and small down payments may find FHA or USDA loans to be their best or only option. In this case, plan to refinance your way to cheaper financing when your credit score and equity positions have improved.

Split or single premiums

One-time premiums allow you to avoid monthly mortgage insurance by paying it all up front. Split premiums allow you to make lower monthly payments by paying a partial premium up front. And if your salesperson is motivated, you might be able to get them to pay for you.

Related: Getting Sellers to Pay Your Closing Costs

Cancellation

Conventional loan guidelines allow borrowers to request cancellation of their EM after their loan drops to 80 percent of the home’s value when you took out your mortgage. You would normally need to be in good standing with your lender to abandon MI this way.

With FHA and USDA mortgage loan insurance, coverage continues for the duration of the loan. For funding supported by VA, there is no monthly fee.

Automatic termination

Alternatively, mortgage insurance for conforming loans “should automatically end the PMI on the date your principal balance is expected to reach 78% of your home’s original value.” For your PMI to be canceled on this date, you must be up to date with your payments by the scheduled termination date. Otherwise, PMI will not be terminated until shortly after your payments have been updated.

it takes years

It can take a long time for a home to reach the 78 percent benchmark. For example, if you buy a house for $ 300,000 with a 5% down payment, the mortgage amount will be $ 285,000. At 4.625% interest, the loan balance will not drop below $ 234,000 – 78% of the property’s original $ 300,000 value – until month 112 of the amortization schedule. That’s 9.3 years away, for many borrowers it’s well after the property has been sold or refinanced.

See if refinancing will get rid of your mortgage insurance (June 14, 2021)