What Is Mortgage Insurance?First, you need to know what mortgage insurance is. Mortgage insurance (also called MI or PMI) is an insurance policy which compensates lenders or investors for losses due to the default of a mortgage loan. In a nutshell, if you don't pay the loan back and the bank has to foreclose on you, it covers the shortage so that the bank doesn't take a loss. The cost for this insurance is added into your payment each month, making you pay more for the home.
What Determines the Cost?The cost for mortgage insurance is impacted by several factors. The most important one is the type of loan you are using:
- VA Loan - a VA loan has no monthly mortgage insurance cost which is awesome. Because this type of loan is only available to eligible Veterans, it isn't a fit for most buyers. If you are a Veteran though, DEFINITELY look into this. It's a significant savings.
- USDA Loan - a loan guaranteed by the USDA has a lower monthly cost for mortgage insurance (currently 0.4% of the loan amount per year). This is normally one of the lower priced routes to go, but, like VA, this type of loan isn't for everyone. It can only be used when buying in USDA eligible areas. Your household income can't exceed a certain level also. To look at the income and geographic limits that pertain to you, go here: USDA Property and Income Eligibility.
- FHA Loan - For most FHA buyers, there is a big-old charge for mortgage insurance added into you payment. Currently, it's 1.35% of the original loan amount annually (paid in 1/12th increments each month). Typically FHA is the most expensive option so it should not be a buyers first choice unless other factors about FHA make it necessary. FHA is more flexible with lower credit scores, lower down payments and higher debts so sometimes this higher charge for mortgage insurance is necessary to get these looser guidelines.
- Conventional Loan - If you're not a Veteran or buying in a USDA eligible area, this is the option you should be exploring more because it gives you more control over the mortgage insurance premium. How's that, you say? I'm glad you asked.....
Getting Cheaper Mortgage Insurance on Conventional LoansThere are reasons why conventional financing won't work for certain buyers (see FHA bullet above for a partial list). If you don't need the increased flexibility offered by FHA financing, though, you can typically save money by using Conventional financing and getting savvy on the mortgage insurance. Here's how to reduce the cost:
- Increase your down payment - the cost for mortgage insurance is tiered based on the percentage of down payment you have. It gets cheaper with every 5% threshold you hit. These are the current rates with Radian (one of the top four MI providers): For 5%-9.99% down - 0.59% per year. For 10%-14.99% - 0.44% per year. For 15%-19.99% down - 0.28% per year. With down payments of 20% or more, mortgage insurance is no longer needed.
- Increase your credit score - those rates mentioned above are assuming your credit score is 760 or higher. What if it's 720 or 740 though? That MI cost with 5% down increases from 0.59% to 0.67% per year. If your score is 700 it goes up to 0.94%. Given how much the premium can move with a relatively minor change in your credit score, it's worthwhile to try to get your score up as high as you can before buying a home.
- Have your lender shop it around - the last important step is to make sure you're working with a lender who shops the mortgage insurance around to more than one provider. Surprisingly, not all do this. As a matter of fact, MANY don't. Make sure the lender you pick does so that you're not paying more than you need to be.
Wise home buyers also get wise counsel. Make sure you are doing that by working with a mortgage lender who understands the nuances of mortgage insurance and will educate you on ways you can save money when buying your new home.
Lori Hiscock is a Sr. Loan Officer at Ruoff Home Mortgage‘s South Bend office. One of Michiana’s top mortgage loan officers, Lori started her lending career in 1995 after obtaining her bachelor’s degree in Finance from Western Michigan University. You can connect with Lori Hiscock or apply online here.