Loan Factors

What factors should I consider when deciding whether to choose a loan that requires PMI?
Like other kinds of mortgage insurance, PMI can help you qualify for a loan that you might not otherwise be able to get. But, it increases the cost of your loan. And it doesn’t protect you if you run into problems on your mortgage.
Lenders may sometimes offer low-down payment conventional loans that do not require PMI. Usually, you will pay a higher interest rate for these loans. Paying a higher interest rate can be more or less expensive than PMI - it depends on your credit score, your down payment amount, the particular lender, and general market conditions. You may also want to ask a tax advisor about whether paying more in interest or paying PMI might affect your taxes differently.
Borrowers making a low down payment may also want to consider other types of loans, such as an FHA loan. Other types of loans may be more or less expensive than a conventional loan with PMI, depending on your credit score, your down payment amount, the particular lender, and general market conditions.
You may also want to consider saving up the money to make a 20 percent down payment. When you pay 20 percent down, PMI is not required with a conventional loan. You may also receive a lower interest rate with a 20 percent down payment.
Ask lenders to show you detailed pricing for different options so you can see which is the best deal.
TIP: You have a right to cancel your monthly mortgage insurance premium once you’ve accumulated a certain amount of equity. Learn more about your rights and ask lenders about their cancellation policies.
TIP: Private mortgage insurance protects the lender – not you. If you fall behind on your payments, you can lose your home through foreclosure.

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Private Mortgage Insurance

Private mortgage insurance sounds like a great way to buy a house without having to save up the cash for a down payment. Sometimes it is the only – or even the best – option for new homebuyers. However, there are several reasons would-be homeowners should try to avoid paying this insurance. In this article, we'll examine the six common problems with PMI and explore a possible solution that allows homebuyers to avoid it altogether.

Six Good Reasons to Avoid PMI

1. Cost – Private mortgage insurance typically costs between 0.5% to 1% of the entire loan amount on an annual basis. On a $100,000 loan this means the homeowner could be paying as much as $1,000 a year, or $83.33 per month – assuming a 1% PMI fee. (Calculated as: $100,000 x 1% = $1,000 / 12 = $83.33) By itself that's a pretty hefty sum. However, the average home price, according to the National Association of Realtors is about $230,000, which means families could be spending nearly $200 a month on the insurance. That's as much as a car payment!
2. May Not Be Deductible – Private mortgage insurance contracts are tax deductible – but only if the married taxpayer earns less than $110,000 per year (in adjusted gross income). For married couples filing separately, that threshold is $55,000. This means many dual-income families with a combined income just above the threshold will be left out in the cold. While there are rumors this "income cap" could be raised in the future, there is no guarantee it will happen. Many homeowners (particularly those just above the threshold) may be better off making a larger down payment where at least they'll have the peace of mind that the interest on the loan is be deductible. For more on this important deduction, read How To Get Rid of Private Mortgage Insurance.
3. Your Heirs Get Nothing – Most homeowners hear the word "insurance" and assume that their spouse or their kids will receive some sort of monetary compensation if they die. This is simply not true. The lending institution is the sole beneficiary of any such policy, and the proceeds are paid directly to lender (not indirectly to the heirs first). If you want to protect your heirs and provide them with money for living expenses upon your death, you'll need to obtain a separate insurance policy. Don't be fooled into thinking PMI will help anyone but your mortgage lender.
4. Giving Money Away – Homebuyers who put down less than 20% of the sale price will have to pay mortgage insurance until the total equity of the home reaches 20%. This could take years, and it amounts to a lot of money the homeowner is literally giving away. To put the cost into better perspective, if a couple who own a $250,000 home were to instead take the $208 per month they were spending on PMI and invest it in a mutual fund that earned an 8% annual compounded rate of return, that money would grow to $37,707 (assuming no taxes were taken out) within 10 years.
5. Hard To Cancel – As mentioned above, usually when a homeowner's equity tops 20%, he or she no longer has to pay PMI. However, eliminating the monthly burden isn't as easy as just not sending in the payment. Many lenders require the homeowner to draft a letter requesting that the PMI be canceled, as well as receive a formal appraisal of the home prior to its cancellation. All in all, this could take several months depending upon the lender.
6. Payment Goes On and On – One final issue that deserves mentioning is that some lenders require the homeowner to maintain a PMI contract for a designated period of time. So, even if the homeowner has met the 20% threshold, he or she may still be obligated to keep paying for the mortgage insurance. Check with your lender and read the fine print of a PMI contract for more specifics.

It's Not All Bad

For many Americans PMI is deductible.Those families who itemize their deductions and earn less than $110,000 per year, will find that their PMI is deductible. For a couple with a $250,000 loan and a $2,500 annual PMI payment (1% of the outstanding loan), this deduction could translate into savings of $300 to $400 dollars or more (depending upon the couple's tax bracket).
Also private mortgage insurance often can be paid up front. For those people that don't want to work the cost of PMI into their monthly budgets, some lenders will allow for the payment to be made up front, in cash, at the time of mortgage origination. In some cases the lender will even offer the homeowner a discount for paying up front. Another option that many lenders offer is to add the one-time upfront fee to the outstanding loan balance. The advantage to this is that, amortized over a period of 25 or 30 years, the monthly cost is fairly low.
A final "benefit" of PMI is that once you have finished paying off your insurance policy, the mortgage itself may seem easier to pay down. Of course, this is more of a psychological benefit than a financial one, but it can be a nice feeling to suddenly have a couple of hundred extra dollars coming in each month. Savvy homeowners would be wise to reinvest the money they are accustomed to budgeting for PMI or apply the funds toward the principal balance on the loan. Remember the compounding mutual fund example from earlier.

How to Avoid PMI

In some circumstances PMI can be avoided by using something called a piggy-back mortgage. It works like this: Assume that a prospective homeowner wants to purchase a house for $200,000, but he or she only has enough money saved for a 10% down payment (not enough to avoid PMI). By entering into what is known as an "80/10/10" agreement, the individual will take out a loan totaling 80% of the total value of the property, or $160,000. A second loan, referred to as a piggyback, will also be taken out totaling $20,000 (or 10% of the value). Finally, as part of the transaction, the buyer puts down the final 10%, or $20,000.
By splitting up the loans, the homeowner may be able to deduct the interest on both loans, and avoid PMI altogether. Of course, there is a catch. Very often the terms of the piggyback loan are risky. Many are adjustable-rate loans, may contain balloon provisions, and are due in 15 or 20 years (as opposed to more conventional loans, which are due in 30 years).
Incidentally, many lenders also offer a similar loan arrangement for buyers only able to put down 5% toward a down payment. It's called an "80/15/5" arrangement. It works exactly the same way.

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Mortgage Contracts Insurance

Contracts

As with other insurance, an insurance policy is part of the insurance transaction. In mortgage insurance, a master policy issued to a bank or other mortgage-holding entity (the policyholder) lays out the terms and conditions of the coverage under insurance certificates. The certificates document the particular characteristics and conditions of each individual loan. The master policy includes various conditions including exclusions (conditions for denying coverage), conditions for notification of loans in default, and claims settlement.The contractual provisions in the master policy have received increased scrutiny since the subprime mortgage crisis in the United States. Master policies generally require timely notice of default include provisions on monthly reports, time to file suit limitations, arbitration agreements, and exclusions for negligence, misrepresentation, and other conditions such as pre-existing environmental contaminants. The exclusions sometimes have "incontestability provisions" which limit the ability of the mortgage insurer to deny coverage for misrepresentations attributed to the policyholder if twelve consecutive payments are made, although these incontestability provisions generally don't apply to outright fraud.
Coverage can be rescinded if misrepresentation or fraud exists. In 2009, the United States District Court for the Central District of California determined that mortgage insurance could not be rescinded "poolwide".

History

Mortgage insurance began in the United States in the 1880s, and the first law on it was passed in New York in 1904. The industry grew in response to the 1920s real estate bubble and was "entirely bankrupted" after the Great Depression. By 1933, no private mortgage insurance companies existed.The bankruptcy was related to the industry's involvement in "mortgage pools", an early practice similar to mortgage securitization. The federal government began insuring mortgages in 1934 through the Federal Housing Administration and Veteran's Administration, but after the Great Depression no private mortgage insurance was authorized in the United States until 1956, when Wisconsin passed a law allowing the first post-Depression insurer, Mortgage Guaranty Insurance Corporation, to be chartered. This was followed by a California law in 1961 which would become the standard for other states' mortgage insurance laws. Eventually the National Association of Insurance Commissioners created a model law.
Max H. Karl, a Milwaukee lawyer, invented the modern form of private mortgage insurance and helped put home ownership within reach for millions of families. In the 1950s, Mr. Karl became frustrated with the time and paperwork required to obtain a home backed by Federal Government insurance, the only kind available at the time. In 1957, using $250,000 raised from friends and other investors in his hometown of Milwaukee, Mr. Karl founded the Mortgage Guaranty Insurance Corporation (MGIC). Unlike many mortgage insurers who collapsed during the Depression, MGIC would only insure the first 20 percent of loss on a defaulted mortgage, thus limiting its exposure and creating more incentives for savings and loan associations and other lenders to issue loans only to home buyers who could afford them. The guarantee was enough to encourage lenders across the country to issue mortgage loans to buyers whose down payments were less than 20 percent of the home's price. The availability of credit helped fuel the home building boom of the 1960s and 1970s. By the time of Mr. Karl's death in 1995, more than 12 percent of the nation's nearly $4 trillion in home mortgages had private mortgage insurance.
In 1999 the Homeowners Protection Act of 1998 came into effect as a federal law of the United States, which requires automatic termination of mortgage insurance in certain cases for homeowners when the loan-to-value on the home reaches 78%; prior to the law, homeowners had limited recourse to cancel and by one estimate, 250,000 homeowners were paying for unnecessary mortgage insurance.Similar state laws existed in eight states at the time of its passage; in 2000, a lawsuit by Eliot Spitzer resulted in refunds due to mortgage insurers lack of compliance with a 1984 New York state law which required insurers to stop charging homeowners after a certain point. These laws may continue to apply; for example, the New York law provides "broader protection".
For Federal Housing Administration-insured loans, the cancellation requirements may be more difficult.

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