Reader Question: “My brother pays private mortgage insurance (PMI) on his home loan. He said everybody who makes a smaller down payment has to pay for this extra cost. Is this true? Why is PMI required on certain types of loans but not on others? Have the private mortgage insurance rules changed for 2014, or are they the same as last year? I’m just looking for current information on this subject.”
Home buyers who make down payments of less than 20% typically have to pay for private mortgage insurance on their loans. These policies protect the lender against losses resulting from a borrower who defaults, or stops paying, on the loan debt.
So that answers your first question: Why is PMI required for some home loans but not for others? It has to do with your down payment and, inversely, the loan-to-value or LTV ratio. When the LTV rises above 80%, PMI is almost always required.
The type and amount of insurance you have to pay will partly depend on the type of mortgage product you are using. There are two acronyms you need to know: PMI and MIP.
- Borrowers using government-backed FHA loans typically have to pay a mortgage insurance premium (MIP).
- Borrowers who use conventional (standard) mortgage loans for more than 80% of the home’s value usually have to pay for private mortgage insurance (PMI).
These are private and government versions of the same basic concept. The lender is exposed to more risk as the LTV rises, so they require some form of protection against losses. Statistics show that borrowers who invest less in their homes (by making a smaller down payment) are more likely to default later on. That’s why this type of insurance is required.
Private Mortgage Insurance Rules for 2014 (Conventional)
To answer your second question: The rules for private mortgage insurance in 2014 will be the same as last year. There are no major changes in the works for PMI rules in 2014. The 80% loan-to-value (LTV) ratio mentioned above will still be the primary factor that requires PMI coverage. Borrowers who use a conventional home loan with an LTV above 80% will likely encounter a mortgage insurance requirement, which can increase the size of the monthly payments.
These policies are provided by third-party companies (insurers) that are not affiliated with the mortgage company (the insured) that actually generates the loan. The cost of such a policy will vary based on the size of the down payment and the loan amount. The average cost is roughly $90 per month. But again, it’s a pretty wide spectrum.
Borrowers who can afford to make a down payment of 20% often choose to do so, and for this very reason. It lowers the total cost of the loan by removing the extra insurance component that comes with smaller down payments (and higher LTV ratios). Of course, a 20% down payment is not realistic for many folks. If you fall into this latter group, and you simply cannot afford to put 20% down on a home loan, it’s important that you understand the rules for private mortgage insurance — as well as the potential costs.
Current Rules for Cancelling Your PMI Policy
There are also rules that apply to the cancellation of private mortgage insurance. These rules are part of the Homeowners Protection Act, which was signed into law in July 1999. According to the Federal Reserve, “the act protects homeowners by prohibiting life-of-loan PMI coverage for borrower-paid PMI products and establishing uniform procedures for the cancellation and termination of PMI policies.”
As a result of the Homeowners Protection Act, borrowers have the right to request the cancellation of PMI when they have “reached the date when the principal balance of your mortgage is scheduled to fall to 80 percent of the original value of your home,” according to the Consumer Financial Protection Bureau (CFPB). Lenders typically provide this date in writing, in the form of a PMI disclosure form, when a home loan is first generated. Contact your lender with any questions you have regarding cancellation, or if you cannot find the disclosure form.
Annual and Upfront Premiums for FHA Loans
In addition to the PMI rules for 2014 (for conventional loans), there are certain rules for FHA loans that can increase the monthly payments. By default, any borrower who uses an FHA-insured mortgage to buy a house has to pay two types of mortgage insurance premiums, or MIPs. They have to pay an upfront premium as well as an annual premium. And both have increased in recent years.
Here’s another important development. Due to a new rule introduced in 2014, many FHA borrowers will have to pay the annual premium for the life of the loan, as opposed to canceling it when a certain LTV was reached (as in the past). The annual MIP for an FHA loan can cost anywhere from 0.45% to 1.55% of the base loan amount, per year. To learn more about these insurance rules and requirements, visit our new website: FHAhandbook.com.