Mortgage Financing 101

What is Mortgage Insurance, and how can we avoid paying it?

Let’s start with a little history. It used to be customary in the housing market for purchasers to apply a down payment of at least 20% of the value of the home being purchased in order to procure ownership of the home in question. A sizable down payment was required by the lender in order to dissuade a purchaser from walking away from the investment if anything went wrong with the home (i.e. burst water pipes, bad septic etc.). They would be more apt to fix it than to leave it, because they had so much money tied up in the home that it would be difficult or impossible to walk away leaving the lender holding the bag so to speak…

Why twenty percent and not fifty percent or ten percent?

In the case of a foreclosure, 20% of the value of the home was thought to be enough money to cover any repairs, back taxes, and realty fees that it would cost to get the house back on the market and sold again before the lender would lose any money on it’s investment. Hopefully the purchasers would have owned the home long enough for the house to appreciate a little in value, thus creating an even bigger equity cushion that the lender use to make the new price more tantalizing to a new prospective buyer allowing for quicker sale.

Later, the advent of credit reporting gave the lenders a better picture of a borrowers ability to pay, and lenders were able to more easily discern “good” risks from “bad” ones. As a result many lenders eased lending requirements for people with “good” credit…

Lenders no longer required that a 20% down payment be paid by the borrower, but rather that the borrower pay on an insurance policy procured by the lender to cover that amount of money that the borrower borrowed that is over 80% of the value of the home

(I.E. If a home is worth $100,000.00, and the borrower borrowers $90,000.00, then the loan to value ratio would be 90%. That is the house costs $100,000.00, the lender lends $90,000.00, and the borrower is only required to put $10,000.00 or 10% as a down payment.) In this case the lender would loan $80,000.00 with no problem, however, in order for the lender to loan the full $90,000.00, the lender would require that an insurance policy be taken out to cover the remaining $10,000.00 of the loan in case of foreclosure. No insurance would be required up to 80%, and the insurance only covers that amount loaned over 80% of the value of the home.

This insurance policy is your primary mortgage insurance.

The higher the loan to the value of the home, the higher the insurance premium is required.

Why is a primary insurance premium so bad?

Well it is just money out of pocket that you could spend on other things. Also, a high mortgage insurance premium may raise your monthly house payment enough to prevent you from affording a bigger or better home…

Are there loans above 80% loan to value that do not require mortgage insurance?

Yes! There are several options available. Some lenders provide loans that tout first mortgages that do not require mortgage insurance premiums. These loans usually have a slightly higher interest than other conventional conforming loans on the market, because the lender simply takes the money that you are paying toward the higher interest rate, and they apply it to the premium themselves. Many people turn these loans down because they feel they are getting a better deal on the loans with a lower percentage rate. They often believe that they will save money in the long run, because the mortgage insurance premium will go away once that have paid the loan down (below 80% loan to value), but in actuality these no mortgage insurance loans can be a great deal for the borrower. Let’s face it folks, you can’t write off mortgage insurance, but you can write off interest paid on your home loan, so if your interest rate is a little higher, but you can write it off at the end of the year, and you are not paying mortgage insurance you may be doing pretty well for yourself to look into this type of loan. Just make sure the interest rate isn’t terribly higher than the other conforming conventional loans around.

Another popular option is an 80/10, 80/20, or and 80/15/5… This is mortgage jargon for “a first loan at 80% loan to value, and a second mortgage for the rest not covered by the down payment (if there is one). Because mortgage insurance is only applied to first mortgages over 80% percent loan to value (i.e. PRIMARY mortgage insurance), these scenarios totally avoid it, because the first mortgage would be 80% or less.

These loan structures are very popular, and often one can get into a house without paying a down payment or mortgage insurance. Borrowers are usually given the choice of a HELOC or a HELOAN for the second mortgage.

A HELOC – stands for Home Equity Line Of Credit. It is essentially a credit line attached to your home. Unlike first mortgages, Helocs and Heloans manifest interest rates that are tied directly to the PRIME INTEREST RATE. Those rates are usually higher than the rates on the first mortgages, but the payment is less due to the size of the loan. A HELOC (pronounced HE-lock) is paid just like a credit card in that you will have a minimum payment due each month (usually interest only) and you can pay more if you like to get the principle down. The great thing about helocs is that once you have paid the principle down some, you can use your line of credit just like a credit card. In fact you usually receive a credit card in order to access it. You can charge whatever you want on it, and pay it up or down as you go. Also, since the line of credit is attached to your home, you can usually write the interest off on your taxes just like the first mortgage. The loans are wonderful if you plan on doing any home renovations, because you can charge your materials and write off the interest. You can’t write off credit card interest or interest on cars usually, but when you transfer those balances to your home loan, that becomes a different story. There is usually an annual maintenance fee to keep the HELOC in tact (Usually a couple of hundred dollars per year). Keep in mind that the rate on these loans are usually adjustable, but it is often possible “convert” these lines to self-liquidating HELOANS if you desire at a later date. Ask your lender for details before signing on.

A HELOAN – Stands for Home Equity loan. (Pronounced He-Loan). Heloans, like first mortgages are “self-liquidating” loans. You pay a regular monthly payment at a fixed (usually fixed-ask your lender before signing) interest rate for a set amount of months, and at the end of the term that loan is paid off… The interest can usually be written off like the others, but when it is paid to a zero balance, it is finished. Always get it in writing before you close.

I have already closed on my home, and I am paying mortgage insurance NOW… What can I do about it?

Mortgage insurance usually “falls off” of the loan after the loan amount falls below 80% of the value of the home. Unless prompted by you, your lender will usually go on the value set forth by the appraisal obtained at the closing. Since homes usually appreciate each year, the value assessed at purchase time is usually a low value for your home once you have had the home for more than 12 months. Also if you have made significant improvements on your home, your home may be worth more than it was at purchase.

Most banks will neither consider dropping mortgage insurance nor will they reconsider the value of the home before the loan is at least one year old, but after that, it may behoove you to engage an appraiser to re-value your home at such time that you feel the value of it has appreciated enough to take the loan to value down to 80% or less. Appraisals usually cost anywhere from $200-$400 dollars for single family conventional conforming homes. Make sure to contact your lender before approaching an appraiser, as the lenders usually have preferred appraiser lists, and they may only require a “drive-by” appraisal that could save you a considerable amount of money.

If you are paying Mortgage Insurance now, and your home hasn’t appreciated enough to allow your lender to drop the mortgage insurance, then you may want to ask a mortgage consultant about a Heloc or a Heloan that would apply some of the balance of the first loan to the 2nd mortgage. The balance would have to be enough to pay the principle of the first mortgage below 80% loan to value. Keep in mind that your principle and interest payment for the first mortgage would not change, but rather your first mortgage would simply be paid off sooner, and your total monthly payment would be your original first mortgage payment plus your second mortgage payment. This scenario works for very few.

The last option would be to refinance your loan into an 80/10, 80/20, or 80/15/5 above.