When buying a home there are four elements that generally make up a mortgage payment;
• principal on the loan
• interest on the loan
• property taxes
• insurance
The insurance is mortgage insurance and should not be confused with homeowner's insurance. The purpose of the mortgage insurance (commonly referred to as PMI) is to insure the lender against default on the loan by the homeowner. If a homeowner stops paying on a mortgage, the insurance company ensures that the lender will be paid in full.
Mortgage insurance is not required when a buyer puts a minimum of 20 percent down payment. Studies show that homeowners with less than 20 percent down on a home are more likely to default, making low down payment mortgages more risky for lenders and investors. That is why lenders generally require mortgage insurance for loans with less of a down payment.
Mortgage insurance coverage is arranges for by the lender. There are a range of products and payment options. When shopping for a mortgage, the lender should review all the options with the potential homeowner. The cost of mortgage insurance varies depending on the size of the down payment and the loan, it can run from about one-half of 1 percent of the loan.
In the late 90's the government passed The Homeowner's Protection Act issue to insure that lenders honored consumers' requests to drop mortgage insurance coverage if their loan balance was paid down to 80 percent of the property value and they had a good payment history. In the past homeowners were responsible for requesting cancellation and many homeowners were not aware of this. In many cases, people failed to make this request even after they became eligible and they ended up paying unnecessary premiums that could add up to as much as $1,200 per year. With the new law, both consumers and lenders share responsibility for how long mortgage coverage is required.
Under HPA, the homeowner has the right to request cancellation of PMI when the mortgage is to the point that it equals 80 percent of the original purchase price or appraised value of your home at the time the loan was obtained, whichever is less. The lender does have the right to require evidence that the value of the property has not declined below its original value and that the property does not have a second mortgage, such as a home equity loan.
Under HPA, lenders must automatically cancel mortgage insurance coverage on most loans, once the mortgage is paid down to 78 percent of the value (providing the homeowner has a good payment history). If the loan is delinquent when due for the automatic termination, the lender must cancel the coverage as soon as the loan becomes current. Lenders must terminate the coverage within 30 days of cancellation or the automatic termination date.. Any unearned premiums must be returned to you within 45 days of the cancellation or termination date.
Some lenders will pay for private mortgage insurance referred to as lender's private mortgage insurance (LPMI) and will charge a higher interest rate. Unlike mortgage insurance that you pay, there is no automatic cancellation once you acquire 22% equity. To eliminate the LPMI, you must refinance the loan, which in turn means carefully considering market interest rates and settlement costs at the time to see if refinancing would be an advantage, rather than keeping your current mortgage. An advantage is that it will most likely decrease your closing costs. Do the math to figure out which is going to be the least expensive based on the time you keeping the home
There is an alternate option to paying mortgage insurance without putting the full 20 percent down payment. Bankrate.com recently published the following table explaining the 80-10-10 plan.
By the numbers ... 80-10-10 plan |
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If we compare the purchase of a $150,000 home under the 80-10-10 plan to a standard fixed mortgage including mortgage insurance, we find that the former is $35.36 cheaper each month. Here's how it works: Under the 80-10-10 plan, the 10 percent down payment on a $150,000 house is $15,000. The first mortgage is $120,000 at 7 percent, which comes to a monthly payment of $798.36. The second mortgage for $15,000 has a 9 percent interest rate, making a monthly payment of $120.69. The total monthly payment for both loans is $919.05.
With a $15,000 down payment, one mortgage of $135,000 at 7 percent has a monthly payment of $898.16, plus mortgage insurance of $56.25, making a total payment $954.41. |
|
80-10-10 plan |
Down payment |
|
10% |
$15,000 |
Mortgage 1 |
$120,000 |
7% |
$798.36 |
Mortgage 2
|
$15,000 |
9% |
$120.69 |
Total monthly: |
|
|
$919.05 |
|
|
Standard fixed mortgage plan |
Down payment |
|
10% |
$15,000 |
Mortgage 1 |
$135,000 |
7% |
$898.16 |
Mortgage
insurance |
|
|
+ $56.25 |
Total monthly |
|
|
$954.41 |
TTL MI |
101*56.25 |
|
|
|
However, the total payments over the entire length of the loan of 30 years for the 80-10-10 plan will cost about $1800 more than the standard fixed mortgage plan. Homeowners should consider how long they expect to stay in the home when weighing the options.
