Although it’s often considered a smaller step in the home financing process, private mortgage insurance (PMI) can have a big impact on buyers who don’t have 20% down to put toward their purchase. Many prospective borrowers still believe that the mythical 20% downpayment is the only way to become a homeowner, but this is simply untrue.
Private mortgage insurance affords an opportunity for first-time or repeat homebuyers to purchase a property without saving for years to accumulate a 20% downpayment. Although it is important to note that PMI protects the lender in the event that the borrower defaults on the loan, it also offers assistance for borrowers who might not otherwise be able to purchase a home.
There are specific questions that loan originators and their clients frequently ask in regard to mortgage insurance. Let’s dig into these questions to shine some light on areas that may be confusing for originators and homebuyers alike.
Borrowers commonly wonder how long they’ll have to pay for PMI. The easiest explanation is that they’ll pay until they reach 20% equity in their home. How long this takes varies, depending on the borrower and their financial situation.
Typically, borrowers pay mortgage insurance for five to eight years. There are two factors that can reduce the amount of time that PMI is required. The first is the amortization period, or the schedule of mortgage payments. If the borrower stays ahead of this schedule by paying additional principal on a monthly or periodic basis, they’ll shorten the time it takes to reach 20% equity.
The second factor is home-price appreciation. Although appreciation tends to be unpredictable and is largely dependent on economic and housing-market swings, in many instances it will decrease the length of time that mortgage insurance is required.
The question of mortgage insurance cancellation is an all-too familiar one for any mortgage industry salesperson. But explaining it to borrowers doesn’t have to be complicated.
Simply put, assure your borrower that once they reach 20% equity in their home, they can ask their servicer to cancel the mortgage insurance. In some situations, the servicer may require a new appraisal to confirm that the borrower has reached the 20% threshold. Another way your borrower can remove PMI is through the refinance process. If your borrower has at least 20% equity in their home when they refinance, mortgage insurance won’t be required on the new loan.
Additionally, under the Homeowners Protection Act, the mortgage lender or servicer is required to automatically terminate the borrower’s obligation to pay PMI when the loan is scheduled to reach a 78% loan-to-value (LTV) ratio, or the month following the midpoint of the borrower’s amortization schedule — whichever comes first.
For example, if a borrower has a 30-year loan, the lender must cancel PMI at the halfway point (15 years) even if the loan balance hasn’t reached 78% of the home’s original value, provided that the loan is current. This less common scenario is known as final termination.
It is important to keep in mind that the rules for removal of mortgage insurance are different for conventional loans than they are for Federal Housing Administration (FHA) loans. Mortgage insurance is required on FHA loans for at least 11 years — and in many cases, for the life of the loan — so ending these payments is more complicated and often requires refinancing into a conventional loan. FHA loans also have an upfront premium of 1.75% (which can be rolled into the loan amount), while conventional loans have no such requirement.
There are two types of monthly borrower-paid premiums. These are typically referred to as standard monthly premiums and deferred (or zero) monthly premiums.
With the standard option, the borrower pays the first monthly premium at closing. Some lenders may prefer to utilize the deferred monthly option as it delays the initial PMI payment until the borrower makes their first loan payment. There is no mortgage insurance premium due at closing, which results in lower upfront costs for the borrower.
It’s important to note that the standard monthly and zero monthly options have the same premium rates, meaning the price is the same. The two options simply differ as to when the first PMI payment is made. These differing approaches are completely at the discretion of the lender and what makes the most sense for their borrower.
Mortgage insurance sales professionals are often asked about re-pricing the mortgage insurance premium. This question typically arises when a borrower has paid down a significant portion of the balance early in the loan term but not quite to the required LTV of 80%. Mortgage insurance premiums are based on the loan characteristics at closing. The only way for borrowers to lower their premiums is to refinance into a new loan that reflects a lower LTV.
There are many options to consider when working with borrowers who have less than 20% to use as a downpayment. As an originator, borrowers are likely looking to you for guidance, and mortgage insurance is often a good option for them. PMI can help your clients get into a home much sooner compared to spending years saving up for a 20% downpayment.
Although PMI is an additional cost of borrowing, its benefits outweigh the price tag for many borrowers, and paying for PMI is not a lifelong or even a life-of-loan commitment. Originators who anticipate these types of questions about mortgage insurance and are ready with informed responses are likely to strengthen their client relationships and create a meaningful experience for their borrowers. ●