What is Mortgage Insurance or PMI?

John Thomas December 29, 2018 Tags: Mortgage Insurance, PMI

What is Mortgage Insurance or PMI?

Mortgage Insurance is an insurance policy that protects lenders against a borrower defaulting on the mortgage loan for a portion of the loss incurred by the lender. Mortgage Insurance is sometimes termed PMI which stands for Private Mortgage Insurance. Mortgage lenders typically do not want to lend more than 80% of the value of a home as it is too risky long term. Mortgage insurance is used to offset the risk to the lender and allows a borrower to put down less than 20% to purchase a home so it creates a win-win scenario for lender and borrower. If you have questions or would like to get started on a mortgage pre-approval, call 302-703-0727 or you can APPLY ONLINE

When Do I Have to Pay Mortgage Insurance?

Mortgage Insurance is requirements are dependent on the type of mortgage loan that is being used. The requirements are different for Conventional, FHA, VA, and USDA. The rules for how much you pay and options for buying out the mortgage insurance also depend on the mortgage loan type. Below is summary of mortgage insurance guidelines for each loan type:

FHA Loan MI Requirements

FHA Loans require mortgage insurance on all FHA loans regardless of the amount of down payment. The mortgage insurance factor is the same no matter what the credit score of the borrower. For FHA 30 year fixed rate loans with less than 5% down the mortgage insurance factor is 0.85%. If you put 5% or more down on a 30 year fixed rate FHA loan then the mortgage insurance premium factor is only 0.8%. The mortgage insurance is required for the life of the loan for FHA loans unless you put 10% or more down. If you put 10% or more down then the mortgage insurance will drop off after 11 years.

FHA mortgage insurance also has a special advantage in that the monthly mortgage insurance payment is re-calculated every 12 payments so the mortgage insurance payment goes down every year.

FHA also requires the borrower to pay an upfront funding fee of 1.75% which can be financed into the loan or paid in full at closing.

VA Loan MI Requirements

VA Loans or Veteran Loans do NOT require mortgage insurance which is a huge benefit of a VA Loan. Veterans can borrower 100% financing without paying any extra monthly toward mortgage insurance because the VA guarantees the loan on behalf of the veteran. The VA only requires the veteran to pay a funding fee which they allow to be financed into the new loan. The funding fee amount depends on whether the veteran is active duty or reserves and whether this is the first time use of a VA loan. If veteran has VA disability then they would be exempt from paying the funding fee.

USDA Loan MI Requirements

USDA Rural Housing Loans require the borrower to pay a monthly mortgage insurance premium based on a factor of 0.3% and it is the same regardless of credit score. The mortgage insurance is on for the life of the loan just like FHA Loans. USDA also requires a upfront guarantee fee of 1% which can be financed into the loan. USDA will allow 100% financing so the borrower needs 0% down payment.

Conventional Loan MI Requirements

Conventional Loans require mortgage insurance to be obtain from a private company hence why it is called private mortgage insurance or PMI for short. Conventional loans are the only ones that provide risk based pricing for mortgage insurance. Risk based pricing means your credit scores affects how much you will pay for your private mortgage insurance. The higher the credit score the cheaper the PMI and the lower the credit score, the more expensive the PMI.

Conventional loans do NOT charge any upfront funding fees or guarantee fees like the government insured loans. The mortgage insurance is also cheaper if put more money down and no mortgage insurance is required if put down at least 20%. The PMI will also drop off automatically when the loan balance reaches 78% of the original value or purchase price as long as it has been two years.

What Types of Mortgage Insurance Are Available?

There are three types of mortgage insurance that can be used when mortgage insurance is required:

Borrower Paid Monthly Mortgage Insurance (BPMI)
Lender Paid Monthly Mortgage Insurance (LPMI)
Single Premium Mortgage Insurance (SPMI)

Borrower Paid Monthly Mortgage Insurance (BPMI) is a monthly charge that is added to the monthly mortgage payment. It is the most common type of mortgage insurance. BPMI is the only type available for FHA Loans and USDA Loans. Conventional loans allows for all three types.

Lender Paid Monthly Mortgage Insurance (LPMI) is only available on Conventional Loans. LPMI does not charge the borrower a monthly fee that is added to the monthly mortgage payment like on a BPMI. The lender pays the monthly fee and charges the borrower a higher interest rate on the mortgage loan to provide LPMI.

Single Premium Mortgage Insurance requires the borrower to pay a one time upfront fee to buy out the mortgage insurance premium. The borrower will have a lower interest rate than LMPI and will also not have a monthly mortgage insurance payment like BPMI but the closing costs are increased by the one time buy out fee.

When Can Mortgage Insurance Be Removed?

Mortgage insurance can only be removed on FHA Loans or USDA loans by refinancing the loans into a conventional loan or a VA Loan. A FHA Loan that had 10% or more equity when the loan originated will drop off after 11 years. VA Loans have no monthly mortgage insurance so nothing to drop off. Private Mortgage Insurance (PMI) on Conventional Loans drops off automatically when the loan to value reaches 78% of the original value when the loan was originated.

PMI can also be removed sooner than the automatic 78% removal of original value. The process for removing PMI on a conventional loan sooner than it will automatically dropping off requires the borrower to pay for an appraisal that the lender will order. If the appraised value shows the loan to value is at least 80% then the PMI will be removed. There is also a restriction that the PMI cannot be removed even with an appraisal until the borrower has paid the PMI for a minimum of 2 years.