I have been interviewed recently by several reporters working on articles about mortgage insurance. Their questions made me realize that many consumers are still confused about this important financial tool.
I have written several articles about mortgage insurance myself, but it occurred to me that I should offer a concise explanation of what MI is, how it works and why you may be happy it exists.
Someone borrowing more than 80% of the value of a property presents a greater risk of default. The lender wants to be protected from the possibility of loss, so they will require that the borrower get a policy of mortgage insurance (MI). This limits the potential loss if the borrower defaults on the loan.
The cost of MI varies with the loan-to-value ratio (LTV) and your credit score. Insurance for a 90% loan will cost .44%, or $110/mo for a $300,000 loan if you have a FICO score of 740 or higher. A borrower with a 680 FICO will pay a higher rate: .62%, or $170/mo for the same loan.
The lender will let you drop the MI once the LTV reaches 80%. Different lenders have different procedures, but in most cases, you can order an exterior-only appraisal to confirm the present value (it will cost around $325). If you’ve made your payments on time for at least a year, the lender will agree to drop the MI if the LTV is 80% or lower.
The news is not quite as good for FHA loans. The Federal Housing Administration recently decided, in its infinite wisdom, that the MI (currently 1.35%) must remain on the loan over its entire life. If your property has appreciated to where your LTV is 80% or lower, you’ll have to refinance into a conventional loan to get rid of MI. Even though the rate may be higher than your present FHA loan, the overall cost may drop enough to justify making the change.
Even though mortgage insurance may seem to be an unwelcome cost that benefits only the lender, the fact is that it can help you save money. If your property appraised for a lower price than you had hoped for, paying MI for a year or two can help you take advantage of today’s lower rates. Just be aware of your property’s value as it appreciates—your Realtor® would be more than happy to keep you informed—and get it removed as soon as your LTV drops to 80%.