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How to Choose Private Mortgage Insurance

There are numerous options to get a mortgage with only a small down payment, contributing as little as 3% or even 0% of the purchase price upfront.

How is this possible? One of the major reasons is mortgage insurance. This financial product helps backstop potential losses your lender would face if you default on your payments, giving them the confidence to issue you a loan.

If you use a federal program to buy a house with a small down payment, you’re limited in what options you have for this type of insurance. But if you take out a conventional mortgage with a down payment of less than 20%, you can shop around for private mortgage insurance.

In this article, we’ll give you the tools you need to get a good deal on private mortgage insurance.

What is private mortgage insurance?

Private mortgage insurance (commonly known as PMI) is typically required to take out conventional loans if you are making less than a 20% down payment. “I think the most important thing for consumers to know is that PMI allows them to have access to affordable low down payment options, and the insurance is cancellable when certain criteria are met,” said Michael Zimmerman, senior vice president of Investor Relations at MGIC.

PMI is a monthly charge that does add to your total payment. But it also enables you to buy a house with much less than the 20% down payment many people mistakenly assume is needed.

When you need private mortgage insurance

PMI is most commonly associated with conventional mortgages. Conventional loans are backed by Fannie Mae and Freddie Mac, which are government-sponsored enterprises that buy and sell conventional home mortgages. The guidelines for getting approved for a conventional mortgage are stricter than government programs like FHA, VA and USDA.

You will need at least a 620 credit score and a  3% minimum down payment. Your debt-to-income ratio, which is a measure of how much debt you have compared to your pretax income, cannot typically exceed 45%.

With private mortgage insurance, your credit score, debt ratio and the type of property you are buying all have an effect on how much the monthly payment is. We’ll show how these factors affect your private mortgage insurance premium later when we compare the mortgage insurance options of all of the different programs side by side.

Government programs do not use PMI — but they do have something similar

FHA loans

The Federal Housing Administration is a U.S. government agency that provides insurance to lenders to make loans to home buyers. FHA loans are a popular choice among first-time homebuyers because they offer easier qualifying guidelines than conventional loans.

Homebuyers with scores as low as 580 can qualify for 3.5% down payment financing, and with 10% down, the minimum score requirement is 500.

FHA mortgage insurance is not impacted by low credit scores, high debt-to-income ratios or property type. Your monthly mortgage insurance is the same regardless of whether you have a 620 credit score or a 720 credit score.

Making loans to borrowers with lower scores and higher debt ratios includes extra risk for lenders. The FHA offsets this risk by charging two forms of mortgage insurance — an upfront mortgage insurance premium (UFMIP) and an annual mortgage insurance premium that is paid monthly (MIP).

The upfront mortgage insurance premium is 1.75% of your loan amount if you make a 3.5% down payment, and the annual mortgage insurance is based on 0.85% of your loan amount with the UFMIP added to the loan amount. This often makes the total monthly payment on an FHA loan higher than a corresponding conventional loan.

VA loans

One of the great benefits provided to current and retired members of the military is the ability to purchase a home with a 0% down payment and not have to pay any mortgage insurance. The Veterans Affairs (VA) charges a one-time lump-sum funding fee instead of monthly mortgage insurance.

The amount depends on whether the military borrower has used their VA home loan entitlement benefits before, and how much of a down payment is being made. The higher the down payment, the lower the funding fee.

For veterans with disabilities related to their service, the funding fee may be waived. This makes the VA loan one of the most cost-effective loan programs for home purchasing, but it is only offered to active-duty military and veterans.

The funding fee is the same regardless of a borrower’s credit scores, debt-to-income ratio or the type of property being purchased.

USDA loans

The USDA home loan allows lower-income borrowers to purchase homes in rural areas with a 0% down payment.The properties must fall within the areas defined for eligibility for USDA financing.

The USDA loan has a combination of fees that take the place of mortgage insurance to protect lenders who fund them against potential defaults. One of these fees is called the upfront guarantee fee, and it is similar to the upfront mortgage insurance premium on an FHA loan, except the amount of the amount is 1%

The annual fee is similar to the MIP on an FHA mortgage, but the amount is capped at .35% of the loan amount and is paid monthly. Like the FHA, these fees do not fluctuate based on credit score and are the same regardless of property type or debt-to-income ratio.

When you should choose private mortgage insurance

If you have a strong credit profile with credit scores above 680, low debt-to-income ratios and at least 3% of your purchase price in cash for a down payment, then conventional financing is typically the most cost-effective option. However, if your scores are below 680, you may want to consider one of the government home loan options.

Below is a side-by-side comparison of the monthly mortgage insurance costs for a borrower with a 720 score and then a borrower with a 679 score for a $200,000 loan with the minimum down payment. The comparable mortgage insurance for government loan programs is also featured with the minimum credit score requirement for each program.

How PMI Costs Stack Up
Loan type Mortgage insurance type FICO Score Monthly mortgage insurance
Conventional PMI 720 $101.67
Conventional PMI 679 $175
FHA MIP 580 and higher $144.15
USDA Annual guarantee fee 640 and higher $58.33
VA Funding fee, no monthly payment No minimum score N/A

The conventional mortgage insurance premium is clearly the winner for cost savings — as long as you have a score of at least 720. Once you drop below 680, the conventional PMI is more expensive.

One note about USDA loans: Although the monthly fee is lower, the restrictive income maximums combined with the lower prices of most rural homes make it unlikely that you’ll be purchasing a USDA home with a loan amount of $200,000.

On the surface, it seems that private mortgage insurance is the clear winner for high credit scores and lower debt ratios. However, if you are are buying a manufactured home, the monthly mortgage insurance shoots up to $135/month, which makes it very important for you to understand the factors that drive a private mortgage insurance premium quote.

Factors that can increase your private mortgage insurance payment

The list below features items that add to your mortgage insurance premium. Keep in mind, each one is a separate adjustment, so like the example above, the more factors that are applicable to your PMI quote, the higher the monthly payment is going to be.

  • Cash-out refinance
  • Second homes
  • Employee relocation loan
  • Manufactured home
  • Condominium/co-op
  • Investment property
  • 3- to 4-unit property
  • Great than 45% debt ratio
  • 1 borrower instead of 2 borrowers
  • Term less than 20 years
  • Adjustable-rate mortgage

Each factor can increase prices on the private mortgage insurance. For example, for somebody with a 700 credit score making a 3% down payment, the typical monthly PMI would be $113.33. If the home is a manufactured home, the price increases to $155. If, on top of that, the borrower’s debt-to-income ratio exceeds 45%, the price can go up to $190 per month.

3 different private mortgage insurance plans

Most borrowers don’t get involved in the mortgage insurance options they have on their loan. The monthly paid option is the most commonly chosen because it’s simple, and loan officers are more focused on getting you your best rate and the lowest fees.

However, there are three different options offered by most private mortgage insurance companies that are definitely worth discussing with your loan officer.

Borrower single premium financed

This option gives you the ability to pay the mortgage insurance in one lump sum, rather than paying it monthly. This may be worth considering if the seller is paying some of your closing costs, as it will eliminate the monthly cost of mortgage insurance.

You can also finance the single premium, which means you add it on to your loan amount. The drawback is that your monthly payment will be higher, but the total payment will be lower than having a monthly mortgage insurance premium.

Lender-paid mortgage insurance

Lender-paid mortgage insurance is a type of PMI that allows the lender to pay your mortgage insurance premium by charging you a slightly higher interest rate for the life of the loan. If you have a credit score over 740, this may be a good option. The interest rate markup is lowest if you have high credit scores.

The drawback is you have the higher interest rate for the life of the loan.

Split premium mortgage insurance

This is a combination of the monthly and single premium options listed above. If you don’t have enough cash or if the seller isn’t paying enough of your closing costs to take advantage of the single premium option, you can pay a portion toward a lump sum to effectively “buy down” the monthly mortgage insurance premium.

Borrower single premium financed and lender-paid mortgage insurance plans give you the ability to buy out or buy down your mortgage insurance, which means your monthly payment will be lower. If you have some extra money saved, or your seller has agreed to pay some closing costs toward your mortgage financing, be sure to discuss these options with your loan officer.

Shopping for private mortgage insurance

“Typically, consumers rely upon the loan officer to pick the PMI company, but there is nothing that prevents a consumer from requesting a specific PMI company,” said Zimmerman. Like any insurance company, rates can vary depending on the type of risk the mortgage insurers take, so if you think the rates are bit high, you can do a little homework yourself.

If you know the basics of your loan, you can use a private mortgage insurance rate finder to determine if the quote you’re getting is at least in the ballpark of something reasonable. Slight variations should be expected, and you’ll need to make sure you have the facts straight.

It’s also worth noting your lender will have to honor the PMI they quote you, unless there is a change to qualifying information on your loan that changes the conditions of the approval (like an increase in debt or a drop in your credit scores).

How to reduce the cost of your private mortgage insurance premium

There are some ways you can save on the cost of your mortgage insurance. Doing more than one of these can lower your premiums substantially.

Apply with the borrower who has the highest credit score

Although this means a slight markup for not having two borrowers, if your score is 740 or higher and you qualify without your spouse, this could save you a substantial amount of money both monthly and over the life of the loan.

Choose a fixed-rate loan program

It may be tempting to get a lower temporary payment with an adjustable-rate mortgage, but if you’re making less than a 20% down payment. your mortgage insurance premium will be marked up. This is because of the risk that your payment will become unaffordable if you don’t refinance before the initial fixed period is up.

Add a co-borrower

If you have a co-borrower who has credit scores equal to or greater than yours, you’ll get a slight improvement to your mortgage insurance premium.  If the co-borrower adds qualifying income that keeps your debt-to-income ratio below 45%, that’s even better news, because your mortgage insurance will be even lower.

Final thoughts about private mortgage insurance

It’s not easy saving up for a 20% down payment, and putting off buying to save up that much means you are probably renting — and that money goes toward building the wealth of your landlord or apartment manager. If you can save up at least 3% of the price of the house you want to buy and have a long-term approach to homeownership, private mortgage insurance gives you options to start your path to homeownership wealth much faster.

 

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