A common request amongst Orange County home buyers is to get a loan with no mortgage insurance. But unless they have a down payment of 20%, or qualify for a specialized program like a VA loan, then understanding what PMI is and why it is beneficial to home buyers with less than 20% down is important.
What is PMI?
If you are entering into a Conventional loan and are going to be paying a down payment of less than 20 percent, the lender will require you pay Private Mortgage Insurance, or “PMI”. Having borrowers pay mortgage insurance protects lenders in the case that the borrower forecloses. Private Mortgage Insurance will usually vary between .2% and 1.5% and depend on your credit score and down payment size. Obviously, the better the credit score the lower the PMI factor. Also, the bigger the down payment percentage, the lower the PMI factor. It makes sense that a borrower with 15% equity and a FICO score of 740 will pay less for PMI than a borrower with 5% equity and a 620 FICO score. For example, if an Orange County first time home buyer is putting 5% down on a purchase price of $500,000, they will have loan amount of $475,000 (after their $25,000 down payment). If the PMI factor is .62%, then the monthly PMI would be $245, which will be part of the monthly mortgage payment. ($475,000 x .0062 / 12 = $245).
Paying for PMI
There are several potential ways that you can pay for PMI on your loan. The most common way to pay for PMI is through a monthly premium. This amount is simply added on to your monthly mortgage payments as mentioned above. There is also the option to pay an upfront amount when the loan closes that will cover the PMI for the loan. Another possibility to pay for PMI on your loan is that the lender will pay an upfront premium to cover the PMI costs but will in turn increase the interest rate on your loan. This method usually results in a lower payment versus paying it separately from the Principal and Interest. Also, since the PMI is built into the interest rate it will mean you are paying more mortgage interest, which is most cases is tax dedcutible. To downside to building the PMI into the interest rate is that it becomes a permanent part of your loan. If you are paying the PMI separately, you may be able to eventually remove the PMI when you have enough equity in your home, depending on the guidelines your lender and/or PMI company have for PMI removal.
FHA Mortgage Insurance
Potential home buyers with poor credit scores can turn to the FHA mortgage program. The FHA mortgage insurance premium is .85% for loans with a down payment under 5% and will be .8% for loans with a down payment greater than 5%. Unlike with Conventional loans and their PMI, FHA mortgage insurance requires an Upfront Mortgage Insurance Premium (UFMIP) at closing which will usually cost around 1.75% of the loan amount. Most of the time, this up front insurance premium will be financed into the loan, which will bump up the principal and the monthly interest payments. Unfortunately FHA mortgage insurance is permanent and cannot be cancelled like with most Conventional loans. With these extra requirements regarding FHA’s mortgage insurance you will likely end up spending more with an FHA loan when compared to a conventional loan with PMI, although even this will depend on several factors. Because PMI and FHA mortgage insurance factors and guidelines are always changing, it will be important to have an Orange County home loan specialist help with comparing your options.
How to Remove PMI
After you’ve closed your loan and committed to paying PMI you will usually have to keep it for at least 2 years. Once those 2 years have passed and you have reached the point where you have 20% equity in your home you can potentially remove PMI payments from the remainder of your loan. Once you have paid down the balance of your mortgage to 80% of your home’s originally appraised value, you can ask your lender to cancel the PMI on your loan. In order to cancel you have to send the request in writing to your lender and have to ensure that you are up to date on your payments. If you send the cancelation request you might have to get a new appraisal of your home for the lender to show that your loan balance is less than 80% of the home’s current value. In order for your cancellation request to actually be approved you can not have a second loan or any other liens on the home. Having a second mortgage on your home will reduce your equity total and likely make you ineligible to cancel your PMI.
There is also the possibility to cancel the PMI on your loan much earlier during the life of your loan. Your potential options for canceling PMI much earlier include getting a new appraisal, remodeling, and prepaying your loan. These options all help to potentially change your position in negotiating with your lender as well as your current loan to value. The most common way to get rid of PMI is simply by refinancing once there is enough equity to improve your loan. Depending on interest rates, you may be able to lower your rate and payment while removing the PMI all at one time.
Benefits of PMI
While it may seem like Private Mortgage Insurance only serves the interests of lenders because it reduces their potential risks, PMI is also a measure that helps borrowers by lowering the entry barriers to the real estate market. Without private mortgage insurance to help lenders reduce the risk of closing a loan which is over 80% loan to value, many first time buyers would be almost completely locked out of the market. Without PMI as an option, lenders would require 20% down payment. In the example above, our Orange County home buyer would need to save $100,000 rather than $25,000 for the downpayment, which for most potential home buyers would be a daunting task.
The best thing a potential home buyer can do is to find a local Orange County loan officer who can prepare loan scenarios and provide an analysis of the options. A Side by Side Loan Comparison or a Rent versus Own analysis will help potential home buyers understand their options BEFORE that have an accepted offer.
Authored by Tim Storm, an Orange County, CA Loan Officer. MLO 223456. – Please contact my office at the Home Point Financial. My direct line is 949-640-3102. www.OCHomeBuyerLoans.com. I will prepare custom loan scenarios which will be matched up to your financial goals, both long and short term. I also prepare a Video Explanation of the your scenarios so that you are able to fully understand the numbers BEFORE you have started the loan process.