- - Thursday, November 3, 2011

Potential homebuyers eager to take advantage of today’s low mortgage rates and relatively more affordable home prices sometimes are stymied by the prospect of accumulating a substantial down payment.

While Federal Housing Administration (FHA) loans are available with a down payment of 3.5 percent, those loans require both upfront and annual mortgage insurance payments. Conventional mortgage loans require private mortgage insurance (PMI) on loans with a down payment of less than 20 percent, but in some cases, the PMI payments along with the principal-and-interest payments will be lower than payments on an FHA loan of the same size.

“When the FHA changed their mortgage insurance premiums and the loans became more expensive, we saw an immediate shift in preference toward conventional loans,” said Nathan Burch, president of McLean Mortgage Corp. in McLean. “Conventional loans with PMI can go up to 95 percent and, in some cases, even up to 97 percent of purchase price.”

PMI protects lenders against losses in case of a loan default, which makes lenders more willing to approve a mortgage with less than a 20 percent down payment. According to the Milwaukee-based Mortgage Guaranty Insurance Corp. (MGIC), PMI typically covers 25 percent to 30 percent of a mortgage loan and will absorb that loss if the borrower defaults.

Most lenders offer both FHA loans and conventional loans and can quickly calculate the difference in monthly payments for each potential mortgage scenario.

Borrowers who opt for a conventional loan will need to meet the requirements of the PMI company as well as the lender. In some cases, the PMI guidelines are stricter than the lender’s and the borrower may not qualify for the mortgage insurance.

“The minimum credit-score requirement varies based on the loan-to-value,” said Kevin McMahon, vice president of product management for Genworth Mortgage Insurance in Raleigh, N.C. “On a loan-to-value of 95 percent, we require a minimum credit score of 660, which is a little bit lower than we had been approving recently.”

MGIC’s minimum credit-score requirement on a 95 percent loan-to-value is also 660. The minimum credit score rises to 700 on a loan-to-value of 97 percent and for 90 percent loans of $417,000 to $625,500. Genworth requires a credit score of 720 on mortgages with a 97 percent loan-to-value.

The PMI approval and the amount of the PMI premiums vary according to factors in addition to the credit score. In areas that have experienced extreme hardship in the real estate market, such as Florida, Arizona and Nevada, PMI companies require higher credit scores and may not approve loans with a higher loan-to-value.

“We also look at the debt-to-income ratios of the borrowers,” Mr. McMahon said. “Whenever a borrower has an overall debt-to-income ratio above 41 [percent] to 45 percent, we will increase the credit-score requirement to 740.”

MGIC requires an overall debt-to-income ratio of 41 percent or lower for most borrowers, but those with a credit score of 740 or higher may be qualified for a loan with an overall debt-to-income ratio of as much as 45 percent.

Both MGIC and Genworth also require the borrower to have two months of cash reserves equal to the monthly principal, interest, taxes and insurance payments.

“These days we sometimes see wild swings in credit scores of borrowers,” Mr. Burch said. “Your credit score can go from 690 to 660 in no time if you use your credit cards while you are waiting for a loan approval or pay a bill late. It is so important for consumers to be careful with their credit score because a drop in the score can impact the cost of the PMI payments and the loan approval itself.”

Mr. Burch said PMI companies use risk-based pricing to determine PMI premiums, which are adjusted according to the amount of coverage, the credit score of the borrower and the loan-to-value.

“If someone cannot qualify for a conventional loan with PMI, they may want to try to qualify for an FHA loan,” Mr. Burch said. “Another option is to make a higher down payment, since the credit-score requirements are different for a loan with a 10 percent down payment compared to one with a 5 percent down payment.”

Mr. Burch said a lender can shop around for PMI because each company evaluates risk in a slightly different way.

“Some PMI companies will approve a loan with PMI on a condominium at a 95 percent loan-to-value, while others won’t,” he said.

PMI premiums can be paid via a monthly payment, a single lump-sum payment at settlement or by split premiums, which are a combination of an upfront payment and an ongoing monthly payment. Some lenders also offer “lender-paid” PMI, which typically means the borrower will pay a slightly higher interest rate or higher fees that are then financed into the loan.

Until the end of 2011, borrower-paid PMI premiums are tax-deductible for households with adjusted gross incomes of $100,000 or less. The tax deduction is phased out gradually for households with adjusted gross incomes up to $109,000.

PMI premiums by law must be canceled automatically when the loan amortizes to a 78 percent loan-to-value. Borrowers also can request that their PMI be canceled if their home has increased in value, but they likely will be required to pay for an appraisal to prove that the value has risen and the loan-to-value has dropped below 78 percent.

A popular option several years ago to avoid paying PMI was to take out two loans to purchase a property, such as an 80 percent first mortgage and a 10 percent second mortgage with a 10 percent down payment.

“Second loans are starting to make a comeback, and some small banks will approve them,” Mr. Burch said. “But paying PMI can be cheaper than the payments on two loans. Also, to qualify for a second loan, the borrower has to be the cream of the crop, with a high credit score and a low debt-to-income ratio.”

A lender can be the best resource to compare various loan options, including a mortgage with PMI and an FHA loan.

LOAD COMMENTS ()

 

Click to Read More

Click to Hide