Whenever a first mortgage represents more than 80% of a purchase price (or the appraised value, whichever figure is lowest) private mortgage insurance will be required. This requirement may be circumvented by securing a second mortgage or an equity line of credit to bridge the gap between the buyer’s down payment and the first mortgage, however sometimes an increased first mortgage backed by mortgage insurance is the only or best option.
The cost of the mortgage insurance, otherwise known as its “coverage,” will be determined by a number of factors, such as the borrower’s credit rating, the loan-to-value ratio, the type of property, etc. Once the coverage amount has been determined, the borrower will generally have several options to meet this cost. Payment options for private mortgage insurance on conventional loans will generally include the following:
Single Paid Mortgage Insurance: the cost of the MI is paid off in full at close of escrow through cash from borrower, a seller concession, or by a combination of the two. Within the Single Paid category, the cost may also be covered through a lender credit (Lender Paid) in exchange for a slightly increased rate. Single Paid MI removes any further payment obligation.
Split Mortgage Insurance: the cost of the MI is partially covered through cash from the borrower and/or a seller credit to reduce the monthly mortgage insurance cost.
Monthly Mortgage Insurance: The full cost of the MI is covered in a separate payment that is added to the borrower’s mortgage payment once the purchase closes.
Regarding the various forms of MI, taking a slightly higher rate in exchange for a lender credit (Lender Paid MI) to remove the MI can sometimes help save a deal. We’ve seen loans where the Monthly MI (cost is covered by a separate monthly payment) results in a higher payment than the lender paid option with the slightly higher rate. The lower payment can be the saving grace on some loans by keeping debt ratios at an acceptable level. The one drawback of the lender paid option is that the higher rate is a permanent feature of the loan and cannot be removed. With the other mortgage insurance payment options there is the possibility of eventually removing the MI cost.
Removal of Mortgage Insurance: with the exception of Lender Paid MI, where the MI cost was met in exchange for a slightly increased rate, the other coverage options allow for the eventual removal of mortgage insurance from the loan. The borrower can petition the loan servicer to remove the mortgage insurance once the loan’s remaining principal balance has been paid down to 78% of the original purchase price (or the original appraised value that the loan was based off of). Alternately, if the home’s loan-to-value ratio has dropped to 78% through market appreciation, the borrower can ask to have the mortgage insurance removed after owning the property for two years. If there is increased equity due to a remodel, the borrower can ask to have the MI removed after just 12 months. In either case, the increased value will need to be supported by a new appraisal that is acceptable to the loan servicer. Once mortgage insurance has been removed, it cannot be added back to the loan.