Saturday, March 30, 2013

What is Premium Mortgage Insurance and How Do I Best Utilize It

Can't Afford 20% Down on Your Home Purchase, PMI to the Rescue

What Exactly Is Premium Mortgage Insuarnce

Banks today require a 20% down payment when your purchase a home or multi-unit building used as personal residence.  In other words, the bank wants to be sure you have 20% equity in the home before they will lend you the rest.  This protects them in a couple of ways.

One, if you get into trouble financially, you are going to work a lot harder to come up with your mortgage payments if you might lose the 20% invested in your home.  Second, if your home drops in value after purchase, the banks have a 20% buffer before you are upside down (owe more than the house is worth), and therefore might be willing to walk away from the house, resulting in foreclosure and big losses to the bank.

Premium Mortgage Insurance guarantees the bank that they will get paid if you default.  This allows banks to offer mortgages with as little as 3.5% down payment.  They aren't taking the risk, the insurer is on the hook.

FHA vs Private Mortgage Insurance

The government established the FHA in order to provide such insurance.  This was to help citizens get into homes with as little as 3.5% down.  Until June of 2013, this extra payment for insurance by the homeowner was limited to 5 years or until such time as the homeowner could prove that they had a 20% stake.  The borrower might achieve the 20% equity through larger payments toward principle or by appreciation of the home in the market place.

Unless the FHA changes their present plan, as of June 2013, the FHA version of PMI premium payments will continue for the length of the loan.  The FHA is also proposing to raise their rates April 2, 2013.

Private mortgage insurance is provided by independent businesses.  They have thrived by undercutting the FHA rates.  Generally they will only insure up to 95%, rather than the FHA 96.5%.  A major difference with private insurers, however, is that they do their own appraisals, whereas FHA trusts the bank's appraisal.  This can create issues in a market where prices are moving up quickly.  The bank may have agreed to financing based on 95% of an appraised value of $300,000.  But the private premium mortgage insurance provider might feel the home is only worth $290,000, and therefore only be willing to insure the lesser amount.

A major benefit of the private plans is that they are generally only paid for two years.  

Choosing between FHA and private PMI providers, figuring out what to do when appraisals come in too low, and similar hiccups in the loan process are the benefits of working with a mortgage broker.  The resources available to a broker are much broader and deeper than a bank loan officer.  The broker wants to make the deal work.  That is how he gets paid.  He is constantly looking for the creative way to get past the hurdles.

Tweet This:   FHA Mortgage Insurance Rules to Change June 1, 2013.  Move quickly to save money.  What is PMI?

PMI Seems Expensive, But in Many Cases it Is a Really Good Deal

When is PMI the clear choice?
  • When you don't have 20% down, but you can afford the payments and insurance
  • English: Mortgage rates historical trends
    English: Mortgage rates historical trends (Photo credit: Wikipedia)
  • When you would rather hold on to your cash for other opportunities or investments
The first reason for selecting PMI is obvious.  But what about the second reason?  We are in a very unique lending environment.  With 30 year fixed loans around 3.5%, and ARM's (adjustable rate mortgages) even lower, using your cash to increase the equity in your home may not be a good financial decision.  It may give you more peace of mind and lower your monthly payments, but borrowing money at 3.5% that you can use for any purpose and lock in for decades may be a smarter financial move.   You could use that other 15% not paid into the down payment for:
  • Improvements to your new home
  • Buying other investment vehicles, including other property
  • Increase your payment into your tax deferred pension plan
  • Invest in your business - See our article on using a mortgage to grow your business
  • Use the money for college tuition and expenses
  • Keep the money in savings for a rainy day
Money in your home equity is doing no work for you.  It reduces the interest you pay and that is all it does.  You have lost opportunity costs associated with the otherwise dead money in equity.  It feels good, but it may not be as beneficial in the long run.

Refinance with FHA or PMI

Getting a 95% or 96.5% loan on your home is not limited to purchases.  You can use this approach to do a refinance as well.  You may also want to explore Home Equity Loans or HELOC's as an alternative.  However, these are generally limited to 90% of the value of your home.  

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If you still have questions about the FHA, PMI, or any other part of the mortgage process, don't hesitate to call Bill Rayman for more information at absolutely no charge.  310-295-2900 ext 113

Related Post:  Should You Pay Off Your Mortgage as Quickly as Possible?

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