The What, When and Why about Mortgage Insurance

In the mortgage banking industry, there exist various types of insurance. Unfortunately, consumers as wells as industry professionals often indiscriminately misuse insurance terminology, creating confusion and misunderstanding coverages. In this HUB, I will cover the enigmatic topic of mortgage insurance and related issues. Let me start by telling you what mortgage insurance is NOT. The following insurance coverages are often confused with mortgage insurance but they are in no way related and are intend to cover you, the consumer:

• Hazard Insurance - covers the dwelling and contents of your home against fire, and other natural or manmade disasters.
• Mortgage Disability Insurance - pays out some percentage of the mortgage payment when you're disabled and unable to draw income.
• Mortgage Life Insurance – pays off the mortgage in the event of death.

In the interest of simplification, I will omit VA and USDA loans from the discussion since they do not have monthly mortgage insurance premiums as part of the payment. However, both of these federal loans have federal insurance guarantees backed by the US government. The one-time, upfront cost of this insurance, on VA Loans known as a VA Funding Fee and on USDA loans known as a Guarantee Fee, is normally financed within the loan.

Returning to our focal topic, Private Mortgage Insurance (PMI) and Mortgage Insurance (MI) are differently funded coverages but with the same objective.

FHA Mortgage Insurance (MI)

MI is the type of insurance that covers the lender (not the consumer) against default on a government, FHA loan. It is required on all FHA loans with an exception on the annual insurance premium that will be discussed below. This insurance is a federal program backed by the US government as on USDA and VA loans.

There are two premium components on all FHA loans (with one exception). One is called the Upfront Mortgage Insurance Premium (UFMIP), which as of 10-2010 is now 1% of the loan amount. The UFMIP is normally financed within the loan so it does not affect the cash to close. That is why on Good Faith Estimates, you will see a “Base Loan Amount” or the loan amount without the UFMIP and the “Total Loan Amount” which is higher due to the addition of the UFMIP. The UFMIP is paid only once at the closing and is later remitted to HUD by the lender.

The other premium is the Annual MI Premium. On loans terms that are greater than 15 years where the loan-to-value (LTV) is greater than 95%, as of 10-2010, the premium is 0.90% of the loan amount. If the LTV is equal to or less than 95% the premium is 0.85%. If the loan terms are equal to or greater than 15 years and the LTV is greater than 90%, the premium is 0.25% of the loan amount; if the LTV is equal to or less than 90% no annual premiumwill be charged. This premium is paid on a monthly basis as part of your monthly payment and is remitted to HUD by the servicer of your loan.

The cancellation policy effective for all loans closed on or after January 1, 2001, states that the FHA annual mortgage insurance premium will automatically be canceled once the unpaid principal balance, excluding the upfront MIP, reaches 78% LTV of the lower of the initial sales price or appraised value, based on the initial amortization. Below are additional qualifications on the cancellation policy:

• If the mortgage term is more than 15 years, the annual mortgage insurance premiums will be canceled when the loan to value ratio reaches 78 percent, provided the mortgagor has paid the annual mortgage insurance premiums for at least five years.
• ·If the mortgage term is 15 years and less and with loan to value ratios 90 percent and greater, the annual mortgage insurance premiums will be canceled when the loan to value ratio reaches 78 percent, irrespective of the length of time the mortgagor has paid the annual mortgage premiums.

Furthermore, borrowers can also request through their lenders, cancellation of annual MIP when the 78% LTV threshold is achieved due to a principal reduction payment provided that the loan has been in existence for a minimum of 5 years from the date of origination (except for 15-year term mortgages) and the borrower has not been more than 30 days delinquent on the mortgage during the previous twelve months.

Private Mortgage Insurance (PMI)

PMI is the private sector alternative to FHA MI, that covers the lender (not the consumer) against default on a conventional loan. PMI is required on all conventional loans (any non-government loan) that have an LTV greater than 80%.

There are basically two types of PMI, borrower paid and lender paid. Although the “lender paid” terminology is a bit of a misnomer since the consumer is still paying for the cost. There are six types of basic, borrower paid PMI. (Discuss the options with your mortgage lender.) Each plan is structured to address upfront cash and monthly payments as well as potential refunds for unearned premiums upon cancellation. The pros and cons of each option depends on your personal financial situation, short term and long term objectives.

• Monthly/Zero Monthly Premium MI – Refundable is a payment option that features a coverage term of one month; premiums are remitted monthly and you pay one month’s coverage at closing. Zero Monthly Refundable is a payment option, which features monthly premium rates with no initial premium required at closing.
• Monthly/Zero Monthly Premium MI – Nonrefundable rates feature a lower premium in lieu of a premium refund when coverage is cancelled. No premium will be refunded when coverage is cancelled, unless cancelled under the Homeowners Protection Act of 1998.
• Level Annual Premium MI – Refundable is a payment option that features a coverage term of twelve months; premiums are remitted annually. The Level Annual option features one identical rate for both first year and renewal premiums.
• Single Premium MI – Refundable – you pay a much larger single premium up-front at the time of closing, but have no monthly premium component. Provides refunds according to the refund schedule in the event of cancellation. If, at any time, a refund is required under the Homeowners Protection Act of 1998, a refund of unearned premium will be provided.
• Single Premium MI – Nonrefundable features a lower premium in lieu of a premium refund when coverage is cancelled. No premium will be refunded when coverage is cancelled, unless cancelled under the Homeowners Protection Act of 1998.
• Split Premium MI is a payment option that features a lower monthly rates combined with an upfront premium due at closing. There are three different premium options for split premium MI based upon the required upfront premium amount.
• Lender Paid PMI (LPMI). Here the Lender pays for mortgage insurance in return for a
  higher interest rate. Basically, the lender prices the mortgage so that the mortgage interest rate you obtain incorporates the insurance premium rate. When the lender receives your monthly payment, he splits part of the payment to cover interest, principal and the mortgage insurance being paid behind the scenes. This option was very popular until mortgage insurance was made tax deductable a few years ago.

Cancellation of PMI under the Homeowners Protection Act (HPA) of 1998

The Homeowners Protection Act of 1998 (HPA), took effect on July 29, 1999. The ACT dictates the rules and mechanism for the cancellation of borrower paid PMI when certain conditions are met. HPA applies to loans closed on or after July 29, 1999, which are for single-family dwellings that are the borrower's primary residence, or used in the acquisition, initial construction, or refinancing of that dwelling. The law requires that:

1. Lenders must inform you, at closing and annually, about your right to request private mortgage insurance cancellation and how to do it.
2. If you choose not to request cancellation (as described below), your lender must automatically cancel the PMI for you.

When your LTV is 80% based on the lesser of the sales price or the appraised value at origination, your lender must cancel PMI at your request. You must have a good payment history, no other loans on the house and your lender must be satisfied that your property value has not declined. If you do not request it, the lender must automatically cancel the PMI when the LTV reaches 78% of your home's original value based only on the original amortization schedule (and without regard to any prepayment). Again, you must be current on your payments. (If you're not, the private MI will be cancelled automatically once you become current.)

There are additional qualifications other than the dates given above and the timeliness of payments. Some of the exceptions to HPA are loans considered as "high risk" (verify with your lender if your mortgage falls under this classification) The ACT also does not apply to loans with “lender paid MI." Either way, check with your lender there are State statues that may provide additional consumer protection.

 Tax Deductibility of PMI/MI

Prior to 2007, PMI was not tax deductible and the reason that LPMI was so popular.

But in 2007, the Mortgage Insurance Fairness Act provided that PMI/MI would be tax deductible for borrowers with an adjusted gross income up (AGI) to $100,000 in order to deduct 100% of the premiums, with the deduction incrementally phasing out up to and AGI of $109,000. It applies only to those who have purchased or refinanced a home from 2007-2011. For married homeowners filing separately, there is a $50,000 adjusted gross income threshold per person. The MI tax deduction is reduced by 10% for each $500 that the married borrower’s adjusted gross income exceeds $50,000. The deduction ends this year but can be extended by congress. The following are a few additional qualifiers:

• You do NOT have to be a First-Time Home buyer to take advantage of the deduction.
• The deduction applies to “qualified residences” as defined by IRS code. That means the primary residence and up to one other property selected by the taxpayer that will be used for personal purposes 14 days or 10% of the days during the tax year that the property is rented for fair value, whichever is greater.
• Applies to purchases and refinances up to the original loan amount that can include a 2^nd MTG that closed concurrently when the property was purchased.
• Does NOT apply to cash out refinance transactions.
• Does NOT apply to loans on rental properties.
• There are no loan limits or limits on loan types.