Better Buyers May Prefer PMI

The Federal Housing Administration know as “FHA”, provides mortgage insurance on loans made by FHA-approved lenders throughout the United States. FHA insures mortgages on single-family and multifamily homes and is the largest insurer of mortgages in the U.S., insuring over 34 million properties since its creation in 1934.

FHA mortgage insurance provides lenders with protection against losses as the result of homeowners defaulting on their mortgage loans. The lenders bear less risk because FHA will pay a claim to the bank/lender in the even of a default. Loans must meet certain requirements. Established by FHA by qualify for insurance.

FHA-insured loans typically require a smaller down payment to close a loan and there is more flexibility when it comes to calculating household income and debt ratios. The cost of this mortgage insurance is passed along to the homeowner and typically wrapped into the monthly mortgage payment.

Recently, however, FHA funds have been reduced because of the large number of foreclosures that occurred during the housing decline. As a result, FHA guidelines have now changed, passing on more costs to borrowers in order to build up its reserves (as required by Congress)

Beginning April 1, 2013, the agency raised its annual premium on all forward mortgages by 0.05% to o.10%, depending on the loan amount and the loan-to-value ratio (except single family forward streamline refinance transactions that are refinancing existing FHA loans that were endorsed on or before May 31, 2009). FHA also raised the upfront mortgage insurance premium to 1.75% of the loan amount from 1%.

All lenders require mortgage insurance, either private or government-based, on mortgages with a down payment of less than 20%. (These loans are considered more likely to default than those in which borrowers have more of their own money invested).

Another change in FHA regulations will require borrowers to continue paying annual mortgage insurance premiums (MIP) for a longer period of time—in most cases for the life of the loan. This change will apply to new loans with case numbers of June 3, 2013.

In the past, FHA canceled mortgage insurance on most loans when a borrower, anytime after five years, had made enough payments to reduce the balance to 78 percent of the original loan amount.

For example, a borrower taking out a 30-year loan with 10 percent down would usually eliminate mortgage insurance after about six years making normal payments, or after five years if they made extra principal payments. From June 3, 2013 forward, a borrower starting off with a loan-to-value ratio higher than 90 percent will pay mortgage insurance premiums for the life of the loan or for the first 30 years of the term, whichever occurs first (excluding financed Up-Front MIP). If the original ratio is between 78 and 90 percent, FHA may cancel the premium after eleven years.

These changes may mean that buyers with higher credit scores and higher down-payments may prefer private mortgage insurance (PMI) as a less expensive option. PMI can be cancelled when equity reaches 20% as long as the buyer is current on payments and value of the home is recertified with a new appraisal. Termination of PMI is automatic when the loan amortizes to a 78% loan-to-value ratio—again, as long as the borrower is current.

On a positive note, homeowners can take a federal tax deduction for mortgage insurance premiums on thereMortgage Insurance federal income tax returns. They will receive a maximum benefit of 25% of whatever is paid in mortgage insurance premiums. To take advantage of this benefit, homeowners will have to itemize deductions on their tax return.

Posted in Home Buyer Information, Real Estate.