How to Use Mortgage Insurance to Buy a Home
Mortgage insurance is one of the most misunderstood, and yet most valuable homebuyer assistance tools available on the market today.
- Mortgage Insurance to the Rescue
- Is Mortgage Insurance Tax Deductible in 2019?
- PMI or MIP – What’s the Difference?
- Upsides and Downsides PMI & MIP
- How to Remove Mortgage Insurance
- Mortgage Insurance Alternatives
- Mortgage Insurance Not Required
- Working With a Professional
Mortgage Insurance to the Rescue
Mortgage insurance allows most homebuyers to buy a home with as little as 3%, 3.5% or even 5% down payment.
With less than 20% equity, the lender is looking for additional “collateral” to offset any risk of default that might leave them short of what is owed to them.
Mortgage insurance is an insurance policy that covers the lender in the event of default, which is paid by you, the buyer.
If you want to look at it another way, mortgage insurance is a very small price to pay when weighed against liquidating all of your available cash.
Is Mortgage Insurance Tax Deductible?
The ability to deduct annual mortgage insurance premiums has been a last minute, and retroactive move for the past 5 years.
In February 2018, when The Tax Cuts and Jobs Act was passed, it made mortgage insurance premiums paid in 2017 retroactively tax deductible because the previous deduction had expired in 2016.
It’s been this way for several years now.
There is still time for legislation to pass, making mortgage insurance tax deductible for 2018, and potentially even 2019. We’ll have to just wait and see.
If anything changes, I’ll update this article. I’m following it closely.
PMI or MIP – What’s the Difference?
This is where stuff can get a little confusing. Mortgage insurance isn’t just one thing, it can be different, depending on what type of financing you’re using when you buy your home.
PMI is short for Private Mortgage Insurance, and is offered by private companies to insure Conventional loans that are qualified with less than a 20% down payment.
PMI is often used as a “catch all” term for mortgage insurance. It is actually a very specific insurance policy that you will only find attached to Fannie Mae or Freddie Mac approved Conventional home loans.
One of the greatest benefits of PMI is the ability to scale with your credit score and loan to value. In some cases, PMI is more expensive than MIP, in other cases it can be less expensive.
If you have more than 5% down payment, and credit scores in the low to mid 700’s, Conventional PMI could have a lower monthly payment than FHA’s MIP.
The challenge of PMI comes in when you are trying to get conventional financing with credit scores below 700, and the minimum down payment.
There are some options for splitting up PMI premium payments, however, the most common is a monthly premium paid as part of your mortgage payment.
While you can get an automated underwriting system approval on a Conventional loan with 3% to 5% down payment, the PMI rate is bound to be ugly.
Compare Conventional with PMI to FHA with MIP if your monthly insurance premium rate exceeds .80% to .85%
Because the “Private” in PMI refers to a private company, mortgage insurance providers can sometimes have their own qualifying guidelines.
In the overwhelming majority of cases, PMI companies will follow DU, automated underwriting decision and not require additional underwriting,.
MIP is short for Mortgage Insurance Premium, and is required on all FHA loans.
Qualifying for MIP is automatic when you meet FHA underwriting guidelines.
MIP is simple, predictable, and quite often, the least expensive option for many home buyers.
When taking advantage of the minimum FHA down payment of 3.5% of the purchase price, your monthly mortgage insurance factor is .85%
Simple math – Loan Amount x .85% / 12 = Monthly MIP Payment
But it’s actually a little more complicated than that. You didn’t think a Government program was going to be that easy, did you?
MIP is divided into 2 payments. You have your MIP, which is your monthly mortgage insurance premium, and you have your UFMIP, which stands for Up Front Mortgage Insurance Premium.
Your UFMIP can be financed into the mortgage, and does not affect your down payment or the loan amount that you qualify for.
Your monthly MIP payment is actually calculated, not off the Loan Amount as used in the “Simple Math” example above, but off the base loan amount (purchase price minus down payment) plus your UFMIP.
How MIP is Calculated – Loan Amount + UFMIP x .85% / 12 = Monthly MIP Payment
There is only one price break for MIP, which is at 5% down payment, your MIP factor goes from .85% to .80%. It doesn’t really make sense to scrape to get that last 1.5% down payment, the difference in payment is negligible compared to the investment.
FHA Historical MIP and UFMIP Chart – The most recent change in the MIP, UFMIP premium factors took place in January 2015. With this change, FHA loans will require a 0.85% MIP, with an UFMIP factor of 1.75% of the first loan amount.
Upsides and Downsides of PMI & MIP
There are distinct differences between PMI & MIP, and to be quite honest, you will almost never be in a position where you will have to choose or compare between PMI & MIP.
In almost all cases, you don’t choose your loan, it chooses you, based on your specific qualifying profile and circumstances. The PMI or MIP that follows that loan program is inherited.
Let’s look at the Highlights, and lowlights of PMI:
- PMI Upside – Can be removed when loan principal is paid down to under 80% of the value of the home when you purchased, or refinanced it.
- PMI Upside – Premiums can be quite low with a high FICO score and a lower loan to value, say under 90% LTV.
- PMI Downside – Low FICO scores can make premiums much higher than MIP.
- PMI Downside – With 5% down payment, it will take approximately 11 years to pay your loan balance down to have PMI automatically removed.
And now let’s look at how FHA MIP compares:
- MIP Upside – Mortgage Insurance is always the same regardless of down payment or credit score.
- MIP Upside – Automatic MIP approval with FHA loan approval. Not a separate approval process.
- MIP Upside – FHA offers Streamline Refinance program to lower rate without appraisal or income verification. UFMIP refund available with FHA streamline refinance.
- MIP Downside – MIP is permanent for as long as you have that FHA loan, regardless of loan to value.
- MIP Downside – You must refinance to remove FHA MIP.
A common situation that you might find is that you qualify for a Conventional loan, which in almost all cases means you also qualify for a FHA loan.
In this situation, credit scores and down payment may result in a PMI factor of double or higher the FHA MIP premium. In this situation, you would want to take into consideration your near term and long term goals.
If you plan to stay in the home over the long term, more than 10 years up to lifetime, and you have an opportunity to lock in a great interest rate, you may lean toward a conventional loan using PMI that will drop off on its own. You would not have to refinance to remove the mortgage insurance in this scenario.
If you plan to move in less than 10 years, and you plan to sell, and use the down payment to move to your next home, then FHA might not be such a bad idea if the math makes it an option. There would be no benefit to choosing PMI because it would be approximately 11 years before PMI is removed without refinancing.
How to Remove Mortgage Insurance
The biggest difference between PMI and MIP is the rules around removing mortgage insurance from your payment.
PMI does allow you to have your mortgage insurance automatically removed. However, it typically takes about 11 years for you to pay down the principal balance to 78%, which is when it is automatically removed.
The 78% is based on the sales price or appraised value at the time you took out the original loan. You may also contact the lender at 80% loan to value and ask them to remove the PMI.
FHA MIP is permanent. It stays on the loan regardless of the loan to value. The only way to remove MIP is to refinance out of the FHA loan into a Conventional loan with a loan to value of 80% or lower.
The other way to remove mortgage insurance is to buy it out our roll it in.
3 Mortgage Insurance Alternatives
There are only a small number of options for avoiding mortgage insurance. These are the most popular:
1. Piggyback Mortgage
There is a resurgence of second mortgages, and home equity line of credit programs on the market for buyers with as little as 10% down payment.
These programs allow you to take an 80% loan to value first mortgage, and avoid mortgage insurance, and take out a second mortgage, or home equity line of credit to bridge the gap up to 89.99% loan to value.
Piggyback mortgages are usually reserved for higher credit score borrowers, however, there are programs available with under double digit interest rates, for borrower with lower credit scores.
You can expect that the lower your credit score, the lower the maximum loan to value is on your second mortgage or HELOC.
2. Buy Out PMI Mortgage Insurance
Most lenders can offer a buy out option for conventional mortgages with private mortgage insurance.
This buyout is based on your credit score, and the loan to value of the transaction. Buying out your PMI can be as expensive as 3.29% of the loan amount with 5% down, and a 680 credit score, or 1.92% with a credit score of 760 on the same scenario. This is your FICO range perspective.
With FHA mortgage insurance, you pay the same rate of .85%, no matter what the loan to value.
With private mortgage insurance on a conventional loan, your rates are reduced as your loan to value is reduced. An example of finding an affordable sweet spot might be with 10% down and a 760 FICO, the buyout is only 1.37% of the loan amount. If you’ve only saved up 15% down payment, your buyout is under 1%.
The money to pay for this buyout can come from a seller credit and/or a lender credit, it does not have to come out of your pocket.
3. Lender Paid Mortgage Insurance
LPMI is a version of mortgage insurance that allows you to take a slightly higher interest rate, in exchange for not having a separate mortgage insurance payment.
One of the benefits to this option is that you convert non-tax-deductible mortgage insurance premiums into tax-deductible mortgage interest.
The obvious downside of this option is that you have a higher interest rate for the life of the loan. You would most likely be looking to refinance as soon as it makes sense to, once you believe your loan is 80% or less of the current market value.
Always remember that mortgage insurance is temporary.
You will, at some point, either have enough equity and refinance out of it, or you ride out your PMI principal pay down period and have it removed automatically.
Mortgage Insurance Not Required
Mortgage insurance is not required on all home loans. There are several types of loan programs that do not require mortgage insurance.
- VA Veteran Home Loans do not require monthly mortgage insurance, however, there is a Guarantee Fee which is similar to UFMIP, and can be financed as part of the loan.
- Jumbo mortgages do not require mortgage insurance.
- Portfolio loans do not require mortgage insurance.
USDA Rural development loans require mortgage insurance very similar to FHA MIP. There is an up front Guarantee fee, and a low monthly mortgage insurance payment. USDA monthly mortgage insurance is only .50%
In the case of Jumbo and Portfolio loans, the interest rate will be adjusted to offset the risk of a lower down payment if less than 20% down is required.
Working with a Professional
I can not emphasize enough the importance of hiring a professional, experienced Realtor and loan officer when selling or buying your first home.
When you call a lender from a TV or radio commercial, or click an ad you saw on the internet that has a catchy headline, you are playing competence roulette.
I personally have been in the business for close to 20 years, and started this website 10 years ago to educate and empower consumers.
We have had over a million consumers visit this website and I have answered many thousands of questions from folks all over the Country.
If you are outside of California, I can introduce you to a loan officer from our Expert Network that I personally know and trust.