If you put a down payment on a home that is less than 20 percent of the appraised value or sale price, you are obligated to purchase mortgage insurance. Mortgage insurance, or MI, is also sometimes referred to as private mortgage insurance, or PMI, to distinguish it from FHA and VA insurance, which insures certain governmental programs.
The cost of mortgage insurance will vary depending on the size of your down payment and the loan amount. The amount of mortgage insurance coverage is set by investors such as Freddie Mac and Fannie Mae and is based on your Loan-to-Value Ratio (LTV); the higher the LTV, the higher the coverage that investors will require. A borrower who puts down 20 percent or more on a home, will typically avoid paying mortgage insurance with your monthly mortgage payment.
Mortgage insurance is available in many forms that can be designed to best fit your needs. The most common option is the borrower-paid monthly, where the MI payment is included in the borrower’s monthly mortgage payment. Next, there is a single premium where the MI premium is paid up-front with no additional monthly payment required from the borrower. There is also a split premium program in which part of the mortgage insurance is paid up-front and the remainder is paid in monthly installments that are less than the normal monthly payments would normally be. Lastly, lender-paid MI is available, in which the MI premium is typically included in the interest payment, but usually results in a slightly higher interest rate on your mortgage.
One of the biggest misunderstandings that people have about MI is that it will always be required for the life of the loan. Once your loan amount reaches 80% of the ORIGINAL value, you, as the borrower, can request cancelation. You must request the cancelation in writing, and you may also be required to provide payment history and other documentation to prove your good standing. Even if you don’t request to cancel your PMI, your lender will still terminate your mortgage insurance on the date when your principal balance is scheduled to reach 78 percent of the original value of your home. However, with an FHA insured loan, the mortgage insurance premium does not go away until the terms of the loan are met or you sell or refinance your home.
As an example though, a 30-Year FHA loan with a 3.75% interest rate with .8% mortgage insurance premium would roughly equate to paying 4.65% interest for the life of the loan, which is still close to all-time lows for the U.S. housing market.
Interested in learning more about the home buying and financing process? Our Mortgage 101 Handbook is a great reference for home buyers. Download your free version below!