Mortgage Insurance: A Necessary Evil
June 22nd 2010
Mortgage Insurance…It strikes fear in the heart of most home buyers, or at the very least it makes them angry. I have yet to have anyone say to me that they are happy that they have to pay a chunk of extra money in the house payment just because they don’t have a big down payment. Well, I can’t say that I blame them. Nobody wants to pay anything extra…especially when they really don’t understand what it does. “So Mark” they say, “You mean to tell me that I have to pay this insurance premium every month as part of my house payment to protect the LENDER in case I stop making the house payment?” Well…Yea. Doesn’t seem fair but it really is benficial.
It used to be that banks would only lend to people with a down payment of 20% or more of the purchase price of the house. As you can imagine that left out a pretty big percentage of the population. So the government came up with an idea. If the lenders would loan more then 80% of the value of a home, they would be protected from the additional risk by taking out an insurance policy that would protect them in case the loan went bad. The down side is that the premium on this insurance had to be paid by the home buyer. At first this insurance was provided by the federal government and was done through the Federal Housing Administration and is the same basic package today through FHA loans.
Later on when Fannie and Freddie came into being and were separate from FHA, they had to have some way of protecting the lenders from the possible loss of loans that were not paid back. They went to private financial companies to get the same thing and Private Mortgage Insurance (PMI) was born. PMI is provided by such companies as RMIC, AIG, and MGIC. These companies have suffered with the whole “mortgage meltdown”. You may remember that AIG was the subject of quite a bit of bad press when they needed to be bailed out but then paid out some big bonuses to some of their employees.
A few details to be aware of is that FHA MI and Conventional PMI do basically the same thing but there are a few differences. FHA MI is paid by the borrower in 2 different ways. Part of it is paid as a one time ”up front” mortgage insurance premium that is (at least right now) equal to 2.25% of the loan amount. This one time premium is allowed to be rolled into the loan. The rest of it is paid in the monthly MI premium that is equal to .55% of the loan per year and that is divided by 12. PMI does not have any “up front”portion so all of it is paid in the monthly premium. The PMI amount varies based on the risk. The more you put down and the better your credit is, the lower your PMI will be. The other difference is that FHA will charge their MI for a minimum of 5 years no matter how much money is put down. So even if someone put 20% down but needed an FHA loan, they would pay that MI for the 1st 5 years. PMI is only charged if the borrower does not have 20% or more to put down.
Another thing to be aware of with PMI companies is that since they went through the troubles of the last couple of years, most of them require that they underwrite the loan in addition to the lenders underwriting. They want to make sure that the loan is a good loan so they don’t have to pay out any insurance claims. The bottom line is that without MI or PMI, most people could not get a loan so it seems evil but it’s kind of the price you have to pay for not being able to save up a big down payment.
If you have any questions on this please feel free to contact me