Hundreds of thousands of sales each year would not occur without FHA or VA financing, loan programs that provide assumable mortgages with little or no money down. Yet FHA and VA programs are not for everyone. Many buyers are not VA-qualified, a large portion of all home sales require financing far in excess of FHA loan limitations, and some sellers will not sell to FHA or VA buyers when required to pay large numbers of points.
The FHA and VA programs, however, are not the only sources of institutional mortgage assistance or even the largest. When the success or failure of a sale depends on a small down payment, many buyers turn to a unique financial product called "private mortgage insurance," or PMI, as it is known in the real estate industry.
PMI is nothing more than the promise of a private insurer to repay a lender if a low-down-payment mortgage is in default. Without this promise, a lender would not make a low-down-payment loan, because such financing represents an excessive level of risk.
If conventional financing is available at 12 percent interest with 20 percent down plus two points, conventional financing with PMI also would be available at 12 percent interest plus two points but with only, 5, 10 or 15 percent down plus the PMI premium.
The combination of conventional financing rates plus reduced down payments makes PMI loans popular. Indeed, more PMI loans have been issued in recent years than either FHA 203(b) mortgages or financing backed by the VA, and in some years more than both governmental programs combined.
Because the interest rates for conventional and PMI mortgages are identical, there are no additional points to pay at settlement as is often the case with FHA or VA financing. And, unlike the FHA and VA programs, PMI doesn't require sellers to pay all points; deciding who pays points is a matter of negotiation.
The cost of private mortgage insurance is based on the size of the loan, the type of policy, the length of coverage and the proportion of the property's value represented by the down payment.
Private mortgage insurance can be purchased on either an annual basis or as a multiyear policy. Buyers pay yearly premiums with annual policies, while multiyear coverage is paid in a lump sum at settlement. Of the two formats, annual policies are the most common by far, accounting for 95 percent of all coverage, according to the Mortgage Insurance Companies of America, an industry association.
The size of the PMI premium is determined by the proportion of the acquisition price paid up front--the down payment. A larger down payment means less risk to the lender and so there is correspondingly less need for insurance coverage. With 10 percent down, for instance, there is usually 20 percent PMI coverage. With only 5 percent down, there is 25 percent imsurance coverage.
It follows that more coverage means larger premiums, and that is exactly the case with private mortgage insurance. With 5 percent down, the typical PMI annual premium would be equal to 1 percent of the original loan amount the first year and one-quarter percent of the outstanding loan amount each year the policy is renewed. If the deal requires a 10 percent down payment, a common PMI premium would be one-half percent of the original loan balance and one-quarter percent of the remaining balance each year the policy is continued.
How often are policies renewed? Because PMI is required by lenders as a condition of granting low-interest conventional financing, and because lenders are the beneficiaries of such policies, it is lenders who decide how long the policy will remain in force. In general terms, policies are usually in effect for seven years--fewer years during good times when property values rise and more years during rough times when properties are more difficult to sell.
Multiyear premiums are based on the size of the down payment and the number of years the coverage will remain in force. Multiyear costs would look like this:
For a sale with 5 percent down and 25 percent insurance coverage, the premiums would be equal to 1.2 percent of the loan balance for a 5-year policy, 1.6 percent for 7-year coverage and 2 percent for a 10-year policy.
For a sale with 10 percent down and 20 percent insurance coverage, the premiums would be equal to 1.1 percent of the loan balance for a 5-year policy, 1.4 percent for 7-year coverage and 1.8 percent for a 10-year policy.
Translating these figures into dollars, how much do PMI policies cost and how do such fees compare with FHA and VA programs? Lets look at a 30-year, $75,000 loan.
* With VA there would be a one-half percent "funding fee" at settlement. On a $75,000 loan, there would be an up-front cost of $375.
* The FHA uses a 3.8 percent funding fee. On a $75,000 loan, this would represent a $2,850 charge. Note that if the loan were not outstanding for 30 years, it would be possible to get a partial refund.
* Calculating PMI costs on the mortgage balance at the start of the year, one could expect to pay $1,857.28 for private mortgage insurance payments over seven years using annual policies for a deal with 5 percent down and a $75,000 mortgage. For a sale with 10 percent down and financing worth $75,000, the premiums for seven years would total $1,483.28. These premiums would be paid out on a monthly basis rather than in a single lump sum. Some lenders, however, will require up to a year's payment in advance at settlement, money which is held in an escrow account.
* For a deal with 5 percent down and a $75,000 loan, the cost of multiyear coverage would be $900 for five years, $1,200 for seven years and $1,500 for 10 years. With 10 percent down and financing worth $75,000, the premium cost would be $825 for five years, $1,050 for seven years and $1,350 for 10 years. With multiyear coverage, there is a single up-front payment made at settlement. NEXT WEEK: PMI continued.