For most homebuyers, the biggest hurdle to buying a home is the down payment. Private mortgage insurance, or private MI, can allow you to purchase a home with less down than what otherwise may be required.
Lenders and investors typically require mortgage insurance for loans with down payments of less than 20%. MI provides lenders a financial guaranty should a loan go into foreclosure, which allows many lenders to accept a down payment of less than 20% when making home loans.
Here’s how it generally works:
- A borrower buying a $150,000 home makes a 10%, or $15,000, down payment.
- The lender then obtains private MI on the borrower’s $135,000 mortgage, reducing its exposure to loss from $135,000 to $101,250.
- The private MI covers the top portion of the mortgage – usually the top 25% to 30%. In this case, the MI will absorb 25%, or $33,750, of any ultimate loss to the lender.
What are the benefits?
MI provides an obvious benefit to lenders – it protects them from too much loss in the event of foreclosure. But MI also provides significant benefits to homebuyers, including:
- Buying a home sooner – a higher loan-to-value ratio means you might need less time to save for a down payment
- Increased buying power – if you have a certain amount set aside for a down payment, using MI may help you afford more home than if you put 20% down
- Expanded cash-flow options – you may put less down and keep cash for other uses (making investments, paying off debt, or paying for home improvements or emergencies)
- Receiving a refund – some MI options allow for a prorated refund of premiums upon cancellation
- Faster approvals – loans with MI typically are approved sooner than non-MI or government-backed structures
- Canceling coverage – many MI options may be canceled when no longer needed
MI & FHA
Private MI is the private sector’s alternative to Federal Housing Administration (FHA) mortgage insurance, a government program backed by taxpayers.
Both private MI and the government’s FHA program help borrowers purchase homes with a down payment of less than 20%. Both options are available through most lenders. Choosing the best option will depend upon your individual situation, so you’ll want to consider both options.
As you make your decision, look beyond differences in the monthly payment or interest rate. A mortgage is not a one-day event. Remember to also consider long-term factors like total financing costs and home equity build-up.
FHA financing is a great option for many borrowers, but private MI does offer several advantages:
- Lower total MI expense and increased home equity.The FHA requires an up-front premium that is often financed into the loan, increasing your loan amount and your long-term debt obligation. While PMI does provide an upfront option, the most common type is monthly MI, where there is no up-front MI premium payment (see other options below). Monthly MI could save you thousands of dollars in MI premium paid over the life of your loan and immediately puts you in a much better home equity position.
- Lower or comparable monthly payment. For borrowers with good credit scores or who are putting more than the minimum down, MI is a very competitive option over FHA.
- Chance to cancel your MI coverage. For a 30-year mortgage, the FHA will typically not allow you to cancel the monthly MI payment unless you put down 10% or more at the time you took out the loan. And even then you will need to wait 11 years before you can cancel coverage.
Private mortgage insurance must automatically be canceled once the loan has reached a certain LTV and the borrower may request to have it canceled even sooner. In fact, most lenders allow for a new appraisal to determine if you can cancel your MI and reduce your monthly payment. A new appraisal allows you to take advantage of increases in your home’s value linked to home improvements you’ve made or market appreciation.
The most common private MI option is a monthly premium paid by the borrower. The premium amount appears on your monthly mortgage statement along with your principal, interest and other fees, but the MI does not increase your loan amount, and no additional funds are required at closing. This MI coverage can usually be canceled once your loan amount falls to 75-80% of your home’s value.
There are other MI options to consider, including plans where you pay all or a portion of your MI premium as a lump sum at closing, to reduce or eliminate a monthly premium. Some lenders also offer a plan where they pay the MI premium, but they may increase the loan fees or the interest rate to cover the cost.
Your lender can give you information on what MI and other financing options might mean for your individual situation. Make sure you understand all your options before you decide what’s best for you.