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Mortgage Insurance
Mortgage insurance is an insurance
policy which compensates lenders or investors for losses due to the
default of a mortgage loan. Mortgage insurance can be either public or
private depending upon the insurer. The policy is also known as a
mortgage indemnity guarantee (MIG), particularly in the UK. Mortgage
life insurance guarantees repayment of a mortgage loan in the event of
death or, possibly, disability of the borrower.
For example, Mr. Smith obtains a mortgage loan that exceeds 80% (the
typical cut-off) of his property's value and/or sale price. Because of
his limited equity, the lender requires that Mr. Smith pay for mortgage
insurance that protects their institution against his default. To obtain
public mortgage insurance from the Federal Housing Administration, Mr.
Smith must pay a mortgage insurance premium (MIP) equal to 1.5 percent
of the loan amount at closing. This premium is normally financed by the
lender and paid to FHA on the borrower's behalf. Depending on the
loan-to-value ratio, there may be a monthly premium as well.
Private mortgage insurance
Private mortgage insurance is typically required when down payments are
below 20%. Rates can range from 1.5% to 6% of the principal of the loan
based upon loan factors such as the percent of the loan insured,
loan-to-value (LTV), fixed or variable, and credit score. The rates may
be paid annually, monthly, in some combination of the two (split
premiums).
Borrower-Paid Private Mortgage Insurance (BPMI or "Traditional Mortgage
Insurance")
is a default insurance on mortgage loans provided by private insurance
companies and paid for by borrowers. BPMI allows borrowers to obtain a
mortgage without having to provide 20% down payment, by covering the
lender for the added risk of a high loan-to-value (LTV) mortgage. The US
Homeowners Protection Act of 1998 requires PMI to be canceled when the
amount owed reaches a certain level, particularly when the loan balance
is 78 percent of the home's purchase price. Often, BPMI can be cancelled
earlier by submitting a new appraisal showing that the loan balance is
less than 80% of the home's value due to appreciation (this generally
requires two years of on-time payments first).
Lender-Paid Private Mortgage Insurance (LPMI)
Similar to BPMI, except that it is paid for by the lender, and the
borrower is often unaware of its existence. LPMI is usually a feature of
loans that claim not to require Mortgage Insurance for high LTV loans.
The cost of the premium is built into the interest rate charged on the
loan.
Mortgage insurance in the US
The annual cost of PMI varies and is expressed in terms of the total
loan value in most cases, depending on the loan term, loan type,
proportion of the total home value that is financed, the coverage
amount, and the frequency of premium payments (monthly, annual, or
single). The PMI may be payable up front, or it may be capitalized onto
the loan in the case of single premium product. This type of insurance
is usually only required if the downpayment is less than 20% of the
sales price or appraised value (in other words, if the loan-to-value
ratio (LTV) is 80% or more). Once the principal is reduced to 80% of
value, the PMI is often no longer required. This can occur via the
principal being paid down, via home value appreciation, or both. In the
case of lender-paid MI, the term of the policy can vary based upon the
type of coverage provide (either primary insurance, or some sort of pool
insurance policy). Borrowers typically have no knowledge of any
lender-paid MI, in fact most "No MI Required" loans actually have
lender-paid MI, which is funded through a higher interest rate that the
borrower pays.
Sometimes lenders will require that LMI be paid for a fixed period (for
example, 2 or 3 years), even if the principal reaches 80% sooner than
that. Legally, there is no obligation to allow the cancellation of MI
until the loan has amortized to a 78% LTV ratio (based on the original
purchase price). The cancellation request must come from the Servicer of
the mortgage to the PMI company who issued the insurance. Often the
Servicer will require a new appraisal to determine the LTV. The cost of
mortgage insurance varies considerably based on several factors which
include: loan amount, LTV, occupancy (primary, second home, investment
property), documentation provided at loan origination, and most of all,
credit score.
If a borrower has less than the 20% downpayment needed to avoid a
mortgage insurance requirement, they might be able to make use of a
second mortgage (sometimes referred to as a "piggy-back loan") to make
up the difference. Two popular versions of this lending technique are
the so-called 80/10/10 and 80/15/5 arrangements. Both involve obtaining
a primary mortgage for 80% LTV. An 80/10/10 program uses a 10% LTV
second mortgage with a 10% downpayment, and an 80/15/5 program uses a
15% LTV second mortgage with a 5% downpayment. Other combinations of
second mortgage and downpayment amounts might also be available. One
advantage of using these arrangements is that under United States tax
law, mortgage interest payments may be deductible on the borrower's
income taxes, whereas mortgage insurance premiums were not until 2007.
In some situations, the all-in cost of borrowing may be cheaper using a
piggy-back than by going with a single loan that includes borrower-paid
or lender-paid MI.
LMI/PMI tax deduction
Mortgage insurance became tax-deductible in 2007 in the USA. For some
homeowners, the new law made it cheaper to get mortgage insurance than
to get a 'piggyback' loan. The MI tax deductibility provision passed in
2006 provides for an itemized deduction for the cost of private mortgage
insurance for homeowners earning up to $109,000 annually.
The original law was extended in 2007 to provide for a three-year
deduction, effective for mortgage contracts issued after December 31,
2006 and before January 1, 2010. It does not apply to mortgage insurance
contracts that were in existence prior to passage of the legislation.
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