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What is mortgage insurance and why do I have to pay it?
This blog post has been migrated to my new blog, you can find it here: What is mortgage insurance and why do I have to pay it?
Let's start with the basics - what is mortgage insurance?
Many homeowners feel mortgage insurance is imposed on them by banks for no reason and they don't benefit from it in any way. The reality is that without mortgage insurance, many of those same people would not be homeowners.I feel it is important to note that this post is not about homeowner's insurance, which is required on all mortgaged properties and protects the home and its contents against loss.
Mortgage insurance covers a lender in the event of a foreclosure. Most homes that go into foreclosure sell for less than market value, so if a homeowner doesn't have much stake in a home, the lender is the one who actually loses money. This is where mortgage insurance comes into play. On purchases with less than 20% down payment or refinances with less than 20% equity in the home, a homeowner obtains a mortgage insurance policy to cover the lender in the event of a foreclosure.
Without mortgage insurance, one of two things would happen:
How do I cancel my mortgage insurance (PMI/MIP)?
This blog post has been migrated to my new blog, you can find it here: How do I cancel my mortgage insurance?
Mortgage insurance allows some people to purchase or refinance a home with less than 20% down payment or equity. While it provides a service and helps more homeowners into homes, mortgage insurance is an added cost that should be canceled as soon as possible. First I'll discuss the two main categories of mortgage insurance and then how to cancel each.
PMI vs. MIP
PMI stands for private mortgage insurance and may be attached to conforming, jumbo or USDA home loans. MIP stands for mortgage insurance premium and is required on all FHA loans.
Canceling PMI
The cancellation of PMI was addressed by the Homeowner's Protection Act (HPA) in 1998. Effective after July 29, 1999, certain rules apply to the cancellation of PMI. You can read the HPA documents here.
The first rule set forth by the HPA was that PMI is automatically canceled when a homeowner reaches 22% equity in the property. Another way of saying this is that it is automatically canceled at 78% loan-to-value. The 78% figure is based on the original purchase price and amortization schedule and the homeowner must be current on the mortgage in order for automatic cancellation to apply.
How much do I need to put down on a house?
This blog post has been migrated to my new blog, you can find it here: How much down payment do I need to buy a house?
Conforming Mortgages
Conforming loans are the most popular loans and are often mistakenly referred to as conventional loans (another post for another time). These loans conform to the guidelines of Fannie Mae and Freddie Mac - two mortgage giants. By following conforming mortgage guidelines, lenders are able to sell their loans on the secondary market, which is advantageous to the lender. Read this article to understand why a lender's ability to sell mortgages benefits everyone: Why are home mortgages sold?
Among the most important guidelines Fannie Mae and Freddie Mac set is the minimum 5% down payment. As recently as last year, conforming options included 3% down payment loans, but in November 2013 these mortgages were eliminated.
Conforming loans with less than 20% down payment require private mortgage insurance (PMI). PMI is a monthly payment that protects the lender in the event of a default and is automatically canceled when the homeowner has 22% equity in the home.
The Down Payment Sweet Spot
Conforming loans have a major benefit for people who are able to come up with a larger down payment. At 20% down payment, no mortgage insurance is required on conforming loans. Most people who are able to put down 20% or more on a home purchase choose conforming loans for this reason.
FHA Mortgages
FHA loans are insured by the government and require just 3.5% down payment. This is one of the reasons they remain a popular mortgage option for first time home buyers. This lower down payment requirement is not without its downside, however.
Mortgage Insurance Premium (MIP)
FHA loans require two different types of mortgage insurance premium (MIP). The first type is called upfront mortgage insurance premium (UFMIP) and is required on all FHA loans. The current UFMIP fee is 1.75% of the loan amount. UFMIP is typically financed, meaning it is added on to the loan amount rather than paid by the borrower at the time of purchase.
The second type is called monthly mortgage insurance premium. Monthly MIP amounts vary depending on the down payment and loan term. Currently, FHA's monthly MIP payments are significantly higher than conforming PMI payments. Monthly MIP is required for the life of the loan if the down payment is less than 10% or for a minimum of 11 years if the down payment is more than 10%.
VA Mortgages
VA loans exist to help veterans, service members and surviving spouses obtain favorable mortgage terms. They are partially guaranteed by the government, which allows lenders to offer them with 0% down payment. This makes them a very attractive option for those who qualify. VA loans do not have any monthly PMI or MIP, which is another huge benefit.
VA Funding Fee
VA mortgages do have an upfront fee, somewhat similar to FHA's UFMIP. It is called a funding fee and just like UFMIP, it may be financed rather than paid at the time of closing. The funding fee for a home purchase currently ranges from 1.25-3.30% depending on down payment and whether or not the borrower has used VA benefits in the past. It is important to note that qualifying disabled veterans and surviving spouses are exempt from any funding fees.
Jumbo Mortgages
Jumbo mortgages will vary greatly from lender to lender. A jumbo mortgage is one that has a higher loan amount than the conforming limits will allow. Since they do not follow conforming, FHA or VA guidelines, lenders make their own rules when it comes to jumbo loans. The lowest down payment option I have seen for a jumbo mortgage is 10% down payment. My company currently offers this option for those of you reading this in Arizona.
Many lenders fall into the 20% minimum down payment category when it comes to jumbo mortgages. The amount you are borrowing can also affect the amount of down payment required. The higher the loan amount, the higher the probability is that a larger down payment is required. It is best to consult a mortgage professional or two directly if you are in the jumbo market because rules and options can vary so greatly.
USDA Mortgages
The USDA loan program was developed to help people in rural areas purchase homes at more favorable terms. USDA stands for United States Department of Agriculture (yes, that USDA). The loans have strict limits on household income and the property must be located in an eligible rural area. If both borrower and property meet eligibility requirements, USDA loans offer 0% down payment. They do have an upfront fee called a guarantee fee, which may be financed if the homeowner wishes. They also have monthly mortgage insurance, but the payments are significantly lower than FHA and somewhat lower than conforming mortgage insurance payments.
One Final Note - Down Payment Assistance Programs
They aren't necessarily separate programs, but it is important to know that most areas of the country have down payment assistance programs.
For example, I reside in Maricopa County, Arizona and we have a program called Home in 5 that provides 5% down payment assistance to qualified borrowers. This program can be combined with FHA or VA loans to provide even lower down payment options.
Down payment assistance programs come in too many varieties to cover here. Some require repayment, others do not. Some are actually a second lien on the property, others are simply a grant. Some have payments and interest, others have neither. These programs vary greatly by region, so it's best to do some online research on the topic or, better yet, call a local professional. They can walk you through the ins and outs of options available in your area.
I hope that provides a little clarity on the subject of down payments. As always, thanks for reading my blog!
My website: Mortgage Programs in Arizona
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How do biweekly mortgage payments work?
This blog post has been migrated to my new blog, you can find it here:
What are biweekly payments and why do people choose them?
Biweekly payments are half mortgage payments made every two weeks. They are a subtle way of paying down principal without paying large lump sums of money at a time. For most people, paying half a mortgage payment every two weeks doesn't feel any different than making one payment each month, especially those people who are also paid biweekly.
Here's why they are not the same:
There are 52 weeks in a year, so paying every 2 weeks is 26 half payments. 26 half payments are equal to 13 full payments annually instead of 12 monthly payments.
How much of a difference do biweekly payments actually make?
What is a good debt-to-income (DTI) ratio for a home mortgage?
This blog post has been migrated to my new blog, you can find it here:
I'll answer that question at the end of this post. I think it is important to cover the basics first.
What is a debt-to-income ratio?
Debt-to-income ratio (DTI) is just another way of saying money out vs. money in each month. Lenders use it in order to determine whether they believe a borrower will be able to reasonably repay a loan.
Which debts are included?
The debt portion of a DTI ratio is calculated by adding the amount of monthly payments on all recurring debts. These debts are almost always included:
- Car payments
- Minimum credit card payments
- Expenses for the home being purchased or refinanced
- Expenses for other real estate owned
- Student loans*
- Child Support
- Alimony/spousal support
- Other installment loans (boat, RV, recreational vehicles, lines of credit, etc.)
Why is a mortgage payoff higher than the current principal balance?
This blog post has been migrated to my new blog, you can find it here:
The concept of payment in arrears.
Many people look at their mortgage statement and assume that the current balance is how much it would take to pay off the loan. The truth is that the interest on a mortgage is paid in arrears, so the balance is always lower than the payoff figure. Payment in arrears means that each month's payment is actually paying the interest for the previous month (example: interest for January is actually paid with the mortgage payment on February 1). Think of it like the electric bill - it is paid after the service is used.
The idea of payment in arrears means that whenever a mortgage is paid off, the amount owed is more than the current balance. A certain amount of interest is added for the time that has passed between the last mortgage payment and the date the loan is paid off. This amount will vary depending on the interest rate of the loan being paid off, the amount owed and the day of the month the loan is paid off. A good conservative estimate for the interest amount is about 75% of the current monthly payment. Add that to the current principal balance of the loan and you have a ballpark figure for a total payoff amount.
**Important note: FHA mortgages traditionally charged a full month of interest upon payoff regardless of what day of the month the loan was paid off. This policy is changing soon and FHA will no longer be able to charge a full month's interest after January 21, 2015. Read more about this here.**
The myth of skipped mortgage payments.
How are appraisal values determined on a home?
This blog post has been migrated to my new blog, you can find it here:
What really affects value when it comes to a home appraisal?
I hear the following statement a few times a day, "My neighbor's house is listed for X and mine is bigger, so my house must be worth Y." Replace X and Y with values that make sense in your neighborhood and you've probably heard it too. For this reason, I am going to go over the basics of how a residential appraiser calculates home value. *This is not how commercial properties are valued, but that's another subject for another blog.
Recent comparable sales are everything.
Residential appraisals are based on the three most comparable recent sales ("comps"). More than 3 comps may be used, but typically the three most comparable are given the majority of the weight. A common mistake homeowners make is comparing their home with another that is listed for sale pending sale, but not actually sold. Just because someone lists a home for $1,000,000, doesn't mean that it's worth that much or that someone would pay that amount for it. Pending sales and listed homes may be added to an appraisal report for a little extra support, but they cannot be used as a true comp unless they are closed and ownership has changed hands.
Appraisers usually try to stay within 1 mile for distance and 6 months for age, but this is not always possible. When it isn't possible, the best available comps are used. In large metropolitan areas, it isn't very difficult to meet these standards, but in rural or sparsely populated areas, exceptions must be made.
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