Financing Mortgage Insurance
For conventional loans, there are two ways to pay for private mortgage insurance: (1) by adding a small premium amount to each monthly payment (renewable plan, or annual plan) or (2) by paying a larger, one-time, or single premium at settlement. The single premium plans fall into two categories: refundable premiums and non refundable premiums. Refundable premiums cost more up-front, but you get a refund of the unused premium if you pay off the loan early. If you are planning to keep your mortgage for only a few years, the pay-by-month plan is probably the best deal. If you are planning to keep your mortgage for several years, look into a one-time premium. Most lenders let you add the cost of mortgage insurance to your loan amount so the up-front premium does not increase your closing costs; however, your monthly payment increases to reflect the larger loan.
Financing the one-time mortgage insurance premium has one additional benefit. Mortgage insurance premiums are not a valid income-tax deduction, but if you finance the one-time premium, the interest that you pay on the slightly larger loan amount is deductible. In addition, you can see in Figure 6.6 that the total monthly payment is somewhat less when premiums are financed rather than paid monthly. The disadvantage is that financed mortgage insurance cannot be canceled unless you pay off the mortgage.
With the FHA MIP and the VA funding fee, you do not have the same flexibility that you do with conventional loans. As with conventional mortgage insurance, you may choose to pay the VA funding fee or up-front portion of MIP in cash or finance it. Note that with most FHA-insured loans you still must pay monthly MIP in addition to the up-front premium.
Discontinuing Mortgage Insurance Premiums
If you have a conventional loan with private (renewable or monthly) mortgage insurance or an FHA loan with monthly PMI, your mortgage insurance payments stop automatically when your LTV declines to 78 percent as a result of your normal monthly payments. Because each monthly payment contains a small amount of principal repayment, every month, your outstanding loan balance goes down. As your loan balance goes down, so does your LTV. An 8-percent, 30-year loan at 90-percent LTV takes ten years and seven months to amortize down to 78 percent. An 8-percent, 30-year loan at 95-percent LTV takes 12 years and ten months. Your lender is required by federal regulations to notify you and to cancel your mortgage insurance payments.
If you make additional principal payments, that also reduces your LTV, but you must ask your lender in writing to cancel your mortgage insurance when your LTV is below 78 percent. They are not required to cancel it automatically. If you have had a history of late payments, they may have the right to deny your request.
For conventional loans, you can request cancellation of PMI when your LTV reaches 80 percent through normal amortization. If you have made your payments on time for the last two years, your lender is required to cancel it.
If the value of your home increases, your LTV goes down. With conventional loans, the law allows you to submit a new appraisal to your lender showing that your home is more valuable. You must pay for your own appraisal. If the recalculated LTV is less than 78 percent, you can request cancellation of your mortgage insurance. Again, if you have had a history of late payments, they may have the right to deny your request.
Example: Mr. and Mrs. Homebuyer purchase a $110,000 home with a $10,000 down payment and a $100,000 mortgage. Their LTV ratio is 91 percent, and they must get mortgage insurance. Their annual premium would be $440 per year. In a few years, the value of their home has gone up to $140,000, and they have reduced their mortgage balance through monthly payments to $97,000. Their new LTV ratio would be 69 percent. Their lender will allow them to discontinue the PMI premiums versus $250 for a new appraisal. The $250 reappraisal would save them $440 a year.