- The Washington Times - Friday, January 29, 2010

With the variety of required and optional insurance policies associated with buying a home, it is no surprise that homebuyers can get confused. In addition to homeowners, or hazard, insurance and title insurance, buyers who make a down payment of less than 20 percent are required to pay private mortgage insurance (PMI), or, with a government-insured FHA loan, a mortgage insurance premium (MIP).

PMI is not the same thing as homeowners insurance, which protects the home and its contents. It is not title insurance either, which protects the homeowner and the lender from claims that the residence is not legally the property of the owners. Borrowers also may purchase a mortgage insurance product from life insurance companies that will make mortgage payments in the event of the borrower’s death, but this, too, is not the same as PMI.

PMI provides protection for the lender in case the borrower defaults on the loan.

“Lenders look at the level of risk a borrower presents and price a mortgage loan accordingly,” says Sarah Pichardo, a senior loan officer with George Mason Mortgage in Fairfax, Va. “One of the factors lenders look at is the loan to value. The more money a borrower puts down, the less risk they are to the lender. … Mortgage insurance is priced on a sliding scale; the more a borrower puts down, the less risk to the lender and the less the borrower must pay.”

At the peak of the housing market, many homebuyers opted to finance their home purchase with a small down payment and a combination of loans, which allowed them to avoid paying PMI. Combining a down payment of 10 percent with a first loan of 80 percent and a second loan of 10 percent (an 80-10-10), or a 5 percent down payment, an 80 percent first loan and a 15 percent second loan (an 80-15-5), allowed buyers to bypass the lender requirement for PMI. In addition, borrowers often were able to find lenders willing to arrange 100 percent financing. These types of loans are rarely available in today’s lending environment.

The surge in foreclosures and dropping home values has led to a resurgence of loans requiring PMI, because lenders that had approved mortgage loans without insurance have faced significant losses. FHA loans, which now represent about 35 percent of all mortgages, also require a form of mortgage insurance.

For FHA loans, borrowers are required to pay an “upfront mortgage insurance premium” (UFMIP) of 1.75 percent of the loan amount. Borrowers typically wrap that premium into the mortgage, although they are allowed to pay the premium in full at closing. In addition, an annual mortgage insurance premium (MIP), paid in monthly installments, is required.

On conventional loans, borrowers have the option of paying the PMI themselves or choosing a lender-paid program, although not all lenders offer this product. In addition, borrowers can choose several ways of making the PMI payments.

“Borrowers have the choice of paying the full amount of their PMI at the settlement table, splitting the PMI into a flat fee at settlement along with monthly payments, or paying monthly,” says Alex Lieb, a loan officer with Access Capital Mortgage, an affiliate of Presidential Bank in Bethesda, Md.

Mr. Lieb says borrowers need to realize that PMI eventually can be canceled as the loan is paid down or property values rise.

“Some loan programs will automatically cancel PMI once the loan-to-value reaches 78 percent on the property,” Mr. Lieb says. “Otherwise, the homeowners may have to petition to have their PMI canceled.”

Scott Davis, branch manager of Prosperity Mortgage Co. in the District, says the choice between borrower-paid PMI and lender-paid mortgage insurance depends on each buyer’s individual circumstances.

“Lender-paid mortgage insurance means that the borrowers accept a slightly higher interest rate for their loan, such as .25 or .50 above the rate they would qualify for, with the advantage of not paying any monthly PMI,” Mr. Davis says. “The only negative aspect of that is that the extra interest rate will be there for the life of the loan, even when the loan goes to more than 78 percent loan-to-value. You can’t change the interest rate.”

Mr. Davis says monthly PMI payments generally cost about $200, so paying slightly more in interest for lender-paid mortgage insurance usually results in a smaller monthly mortgage payment than paying PMI.

Ms. Pichardo says a $300,000 loan with a 5 percent interest rate and a 5 percent down payment would require a monthly PMI payment of about $195, so the total monthly payment for principal, interest and PMI would be $1,805, not including real estate taxes and homeowners insurance. With lender-paid mortgage insurance and an interest rate of 5.25 percent, the monthly payment would be $1,656, a difference of $149 per month.

“If the debt-to-income ratio of the borrower is tight, lender-paid mortgage insurance might be a better option because it results in a lower monthly payment,” Ms. Pichardo says.

Lender-paid mortgage insurance is fairly popular, she says, but she recommends that each borrower review all the possible scenarios with a lender to see which one makes the most sense for their individual circumstances. Mr. Davis says his customers are divided evenly between choosing PMI and lender-paid mortgage insurance.

“The main benefit to borrowers choosing to pay monthly PMI rather than the lender-paid option is the eventual ability to get rid of the PMI,” Mr. Davis says. “But it can be difficult to eliminate PMI. Either the homeowners have to make additional payments to reduce the principal [owed] or the property value has to increase. In either case, the owners will need to have an appraisal to prove that the loan-to-value has reached 78 percent.”

Ms. Pichardo says as further proof the loan is not risky, the lender also will require a history of on-time payments for at least one or two years before it will consider eliminating the PMI.

Another consideration when choosing between borrower-paid PMI and lender-paid mortgage insurance is tax deductibility. Borrower-paid PMI is tax deductible for married taxpayers with an income of $110,000 or less, and for single taxpayers making $50,000 or less.

“Lender-paid mortgage insurance wraps the cost into the loan as part of the interest rate, so those interest payments are deductible along with the rest of the mortgage interest you pay,” Mr. Davis says. “In the Washington area, where housing costs are high, most homeowners do not meet the income limitations to deduct monthly PMI.”

In addition to changing the availability of 100 percent financing and combining loan programs to avoid PMI, the foreclosure wave has made mortgage insurance companies less willing to insure borrowers they deem a high risk for foreclosure.

“Statistics have shown that the default rate drops with each 1 percent of down payment made,” Ms. Pichardo says. “Mortgage insurance companies base their insurance on the total loan amount and a sliding scale, so they look at someone making a down payment of 10 percent as a much better risk than someone making a down payment of 5 percent. They also base their risk determination on the credit score and debt-to-income ratios.”

Ms. Pichardo says companies that offer PMI are unlikely to even consider insuring a borrower with a credit score of 680 or less or someone with a debt-to-income ratio above 41 percent. Borrowers with low credit scores and high debt may be able to qualify for an FHA-insured loan because those loans have slightly looser requirements.

Potential homebuyers will find the best mortgage rates and will not have to make PMI payments if they are able to make a down payment of 20 percent or higher. If they cannot amass enough cash, a lender can help determine whether an FHA loan, lender-paid mortgage insurance or borrower-paid PMI best suits their needs.

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