Some people don’t like mortgage insurance because the borrower pays it and the lender gets the benefit. What these people don’t understand is that this isn’t entirely true. In actuality, lenders wouldn’t loan over 80% of the purchase price (ie. 80% loan-to-value) if mortgage insurance didn’t exist to protect the lender from default. Even with mortgage insurance, it doesn’t guarantee the lender against total loss, it just manages the risk for the lender. It’s also important to understand that the mortgage insurance rate is a fairly significant portion of the APR which is why the APR can be so different than the note rate on loans that require mortgage insurance. With that said, let’s take a look at a scenario where we change a variable or two to see how it impacts the type of loan and amount of payment a homebuyer could have.
The Scenario
Let’s look at a purchase price of $300,000 with conventional, FHA, and VA options. There are three things that will most impact the rate you pay for mortgage insurance on a conventional loan: 1) credit score, 2) down payment percentage which gives the loan-to-value, and 3) debt-to-income ratio. Other factors that impact the rate include the number of borrowers – 2 borrowers is better than, the loan purpose – purchase loans are favored compared to refinance loans, and location – some states get better rates than others. There are some other variables that have slight impacts on the rates but often they are imperceptible. Mortgage insurance for FHA loans is the same rate regardless of credit score or any other of the variables I mentioned above. VA loans don’t have mortgage insurance but they do have a funding fee that is usually financed in the loan. The funding fee is waived for disabled veterans who have a specific minimum disability rating. The rate on it is 2.15% for first time use and 3.3% for subsequent use. It doesn’t matter what the actual rates are today but typically FHA and VA rates are about .25% lower than conventional so for our purposes will use a rate of 4.25% for FHA and VA loans and 4.5% for conventional loans.
FHA
Purchase price: $300,000; Down Payment: 3.5% = $10,500. Loan Amount: $289,500.
There are two components to the mortgage insurance for an FHA loan, the up-front portion and the annual portion that get’s paid monthly. The up-front mortgage insurance premium (UFMIP) is 1.75% of the base loan amount: $289,500 * .0175 = $5,066.25. This amount can be paid in cash but in my 24+ years as a loan officer the borrower has financed it on every FHA loan I’ve done. This makes the total loan amount in this scenario $294,566. The Annual premium is .85% of the base loan amount: $289,500 * .0085 = $2,460.75 (this is broken down into 12 equal payments) which equals a monthly payment of $205.06. The principal and interest (P & I) payment on the total loan amount of $294,566 is $1,449.09. With the mortgage insurance payment, the monthly nut is $1.654.15. One thing to keep in mind is that as of this writing, mortgage insurance on FHA loans is permanent for the life of the loan so the only way to get rid of it is to refinance the mortgage or to sell your home and get a different loan on the purchase of your next home.
VA
The great thing about a VA loan is that there is no down payment requirement – it’s 100% financing. The bad thing is that it is only for veterans and active military so if you haven’t served our country, you don’t get the option to use a VA loan when financing your home. For those who are able to qualify for a VA loan, here’s what this option looks like in our scenario.
Purchase price: $300,000; Down Payment: $0. Base loan Amount: $300,000.
We’ll assume the borrower in this scenario is a first time user of her VA mortgage benefit such that her Funding Fee is 2.15%. On a purchase price / loan amount of $300,000, the funding fee is $300,000 * .0215 = $6,450. This makes the total loan amount $306,450. At our scenario rate of 4.25%, the monthly payment is $1,507.55. The payment on the VA loan is $146.60 less than the payment on the smaller FHA loan AND the VA borrower gets to keep the down payment ($10,500 on the FHA loan) and use it for investments, or fixing up her new home or whatever she wants.
Conventional
Here’s where it gets interesting because of all the options – both in the percentage you put down as well as how you decide to pay your mortgage insurance. Let’s start with the 3% down payment options – yes, that’s a lower down payment than FHA!!
Purchase price: $300,000; Down Payment: 3% = $9,000. Loan Amount: $291,000. Let’s assume a credit score of 720 (borrowers with higher credit scores are more likely to choose conventional loans because of the flexibility when it comes to mortgage insurance).
At an interest rate of 4.5%, the P & I payment on a $291,000 loan is $1,474.45. Here are some common mortgage insurance options:
- Monthly mortgage insurance: rate = .74%. Premium = $179.45. Total monthly payment including mortgage insurance: $1,653.90. With this option, the payment is .25 cents less than the FHA option even though the interest rate is .25% higher. The borrower puts $1,500 less down on the home AND she has the ability to get rid of the mortgage insurance at some point (see below).
- Single-pay mortgage insurance: rate = 2.55%. Premium = $7,420.50. The total monthly payment in this scenario is just the P & I payment of $1,474.45 since the mortgage insurance is all paid up front. The money for this can come from a gift. The break-even period is calculated as follows: $7420.50/$179.45 = 41.351 months. Hence, if the borrower thinks she will have the mortgage for 42 months or longer, this makes sense to do if she has the money to do it.
- SplitEdge: This is an option that looks like FHA where you pay part of your mortgage insurance premium up front and the rest on a monthly basis. The borrower has the option to pay between .25% of the loan amount and 1.75% of the loan amount up front. In this case, the borrower will pay 1% up front. Premium = $2,910 up front and 140.65 monthly. The up-front amount is $2,156.25 less than with an FHA loan and the monthly amount is $64.41 less than FHA’s. The total mortgage payment with the MIP is $1,615.10 – that’s a payment savings of $39.05 per month vs. the FHA option and the borrower saves $1,500 on the down payment. The down side to this is that the up front portion of the mortgage insurance has to be paid at closing by the borrower where as on the FHA loan it can be financed.
- Lender Paid Mortgage Insurance. This is another option but I am not a fan of this and here’s why. With this option, the rate gets raised anywhere from about .375% to .75% and there is no possibility of getting rid of your mortgage insurance in this scenario without refinancing the loan. I would always choose the first option instead of this.
Let’s look at one more scenario under the conventional heading: 5% down payment. This option still allows for a relatively low down payment while providing better terms. The loan amount with 5% down would be $285,000 (with a down payment of $15,000) and the P & I payment is $1,444.05.
- Monthly mortgage insurance: rate = .57%. Premium = $135.38. Total monthly payment including mortgage insurance: $1,579.43. That’s a monthly savings of $74.47 vs. the same option with 3% down. You can see what a significant improvement the borrower gets in the mortgage insurance terms with 5% down vs. 3% down.
- Single-pay mortgage insurance: rate = 2.02%. Premium = $5,757. Total monthly payment is the P & I payment of $1,444.05 ($30.40 less than the 3% down option). The borrower saves $1,663.5 in premium.
- SplitEdge: The up-front premium is 1% ($2,850) but the monthly rate is .39% with a premium of $92.63. The total monthly payment with mortgage insurance is $1,536.68 – a savings of $78.42 vs. the SplitEdge option with just 3% down.
How You Can Get Rid of Mortgage Insurance
The bonus with mortgage insurance on conventional loans is that you can get rid of it at some point. Here’s how it works. The borrower can request its remove when they have paid down the loan to 80% of the purchase price; in this scenario, once the loan balance hits 80% of $300,000 ($240,000), the borrower can request its removal. The lender is required to cancel the mortgage insurance with no borrower action when the balance of the loan reaches 78% of the original purchase price, $234,000 in this scenario. One other way to get ride of mortgage insurance is with appreciation. If a borrower has had the loan for a minimum of 2 years and thinks the home might have appreciated to the point where the loan to value based on the current loan balance and the value of the home is 75%, she can contact the lender and request that they do an appraisal. The lender will order an appraisal and if the LTV is at 75% or below, the mortgage insurance will be removed.
Feel free to contact me at (702) 812-1214 or (801) 893-1737 or by email at jed.wunderli@noblehomeloans.com if you have any questions or would like to see what your financing options are.
