What Is Prepaid Mortgage Insurance (PMI)?
For modest-income borrowers lacking the means to put down 20% on a home purchase, the Federal Housing Administration has made home ownership more attainable by offering prepaid mortgage insurance (PMI). The FHA charges one-time as well as recurring mortgage insurance premiums which are used to build the reserves that pay lender claims should a borrower default on the loan. In the following breakdown, I’m going to explain the types of PMI and some of the rules governing it.
FHA loans, which are appealing with their low 3.5% minimum down payment requirement, actually require two forms of mortgage insurance:
- Upfront Mortgage Insurance Premium (UFMIP), which equates to 1 to 1.75% of the loan balance, is usually rolled into the FHA loan’s balance and is paid as part of the monthly mortgage payment. Under this arrangement, the borrower is charged interest on it and is able to deduct the mortgage interest that it accrues along with the interest on the rest of the mortgage balance.
- Additionally, an annual MIP (1.15 to 1.5% of your loan balance every year) is also levied on all FHA loans longer than 15 years, but is billed to the borrower in monthly installments.
Borrowers with the ability can prepay the UFMIP in a lump sum at closing or may pay it over the life of the loan by adding it to the principal balance. Although prepaying the UFMIP at closing has its appeal, most FHA borrowers finance the fee to keep their closing costs down. When opting to prepay the UFMIP you must demonstrate prior to closing that you have enough money to cover it, plus your down payment and other closing costs. Keep in mind though, financing the UFMIP helps you qualify with limited available funds.
It is dependent on your lender whether you’d be allowed to pay your annual MIP on an FHA loan in yearly installments, versus monthly. FHA guidelines require that the monthly installment on the annual MIP be calculated into your monthly debt-to-income ratios, which may decrease the home loan amount for which you qualify.
Conventional (non-FHA) loans have only an annual, or ongoing, PMI requirement. If you’re getting a conventional loan there are alternatives for eliminating PMI altogether.
- You might qualify for a home equity line of credit to increase your required down payment to 20%, thus avoiding the need for PMI altogether.
- There is also an option called single premium mortgage insurance, a 1-2% fee made at closing that pays for your mortgage insurance upfront in a single lump sum.
Both above options for avoiding PMI in your monthly payment appeal to borrowers struggling to qualifying for their ideal purchase price due to the mortgage insurance fees escalating payments beyond what loan guidelines indicate they can afford.
- Also, loan programs exist that allow for LPMI (lender-paid mortgage insurance) where you pay a higher interest rate in exchange for the lender paid insurance.
- Finally there are buyer-paid mortgage insurance-backed loans where you elect to pay your yearly PMI premium on an annual, lump-sum basis at the start of each year.
With both these options you will avoid having the PMI premium added into your monthly mortgage payment, but it won’t help you afford a more expensive home.
Cancellation of PMI
There is a set of rules that oversees the cancellation of MIP and PMI. First, lenders are required by law to cancel mortgage insurance once the loan amount is at or below 78% of the original value of the home. This rule varies between FHA and conventional loan products.
The UFMIP and the annual mortgage insurance premium are two separate FHA costs, with the primary difference being that the annual mortgage insurance premium may be dropped over time as the loan is paid down (and subsequently the home equity increases). Staying straight on mortgage payments for at least five years and building a minimum of 22 percent equity leads to automatic cancellation of the annual mortgage insurance premium.
- Note that even when your home loan scenario meets the 78% standard, you must also have been paying annual MIP for at least five years (60 months) for the MIP to be canceled, as opposed to conventional loan scenarios which do not have the duration of payment requirement.
Conventional lenders are required to cancel the PMI policy when the loan is paid down to 78% of the home’s original purchase price or appraised value (whichever is lower). However, borrowers may request that PMI be canceled whenever they can document that they’ve met the following conditions:
- Their mortgage balance is 80% of the original value of the property
- The borrower’s payment history is solid
- The borrower can deem that no subordinate loans are on the home
- The borrower can provide evidence (described by the lender in its annual notice) that the property value of her home has not declined
If you think your home’s value has increased enough for your loan to qualify for meeting the 80%–or-less requirement, discuss getting a new appraisal on the property with your lender, and use the new appraised value as a basis for canceling PMI.
With either type of loan, the government has also provided to borrowers The Homeowners Protection Act of 1998 which stipulates that if the borrower has paid for private mortgage insurance in advance, at closing, or is currently paying on an annual basis, then upon cancellation they are entitled to a refund of the unearned premium. This premium must be transferred by the lender within 45 days of cancellation notification. This act was put in place to address borrowers’ concerns that by paying PMI upfront or annually would result in a forfeiture of funds if their home’s equity meets the 78 to 80% mark after payment has been made. It would be up to the borrower to track their home’s equity and apply for PMI cancellation if it has been prepaid.
If you have any further questions on prepaid mortgage insurance, please call me, Brian DuCommun, Loan Officer at Peoples Mortgage, today to discuss your options!
*The statistics I provided came from CoreLogic, a data analytics corporation.
If you liked this post, feel free to share it.