Refinancing & Mortgage Insurance Flashcards
Refinancing is the process of obtaining a new mortgage in an effort to reduce monthly payments, lower interest rates, take cash out of a home for large purchases, or change mortgage companies. Think of it as replacing a mortgage you don’t want for a mortgage you do want. Most people refinance when they have decent equity in their home. Equity is the difference between the amount owed to the mortgage company and the amount the home is worth.
Reasons for Refinancing
Borrowers may consider refinancing for several different reasons:
A lower monthly payment
Shortened loan terms
Changing from an ARM to a fixed rate
Avoiding balloon payments
Getting rid of PMI
Cashing out equity or consolidating debt
Let’s go through each of these!
Refinancing Defined
Maybe a borrower thought that they wouldn’t be in that house very long, so they got an adjustable-rate mortgage. And then things changed and now they want to stay, but they are worried about interest increases.
Luckily, an ARM isn’t permanent and they can refinance out of it and into a fixed-rate mortgage. They may want to switch from an adjustable rate to a 30-, 15-, or 10-year fixed rate mortgage. Switching to a fixed-rate mortgage may be the most sensible option, given the threat of rising interest costs.
Going From Fixed to Adjustable Rate
On the other hand, if interest rates are falling, it could be a good idea to refinance from a fixed-rate mortgage to an ARM. This is a less popular reason for refinancing, but potentially a beneficial one. This could be helpful to avoid future refinances if the interest rate is supposed to drop multiple times in the foreseeable future.
If the homeowner doesn’t plan to stay in their current house for very long, refinancing to an ARM could be a good idea in order to pay less while not having to worry about a future increase.
Going From an Adjustable Rate to a Fixed Rate
Before we get into mortgage insurance, it’s important to understand the concept of LTV ratios. As you’ll see, LTV ratios are used a lot when dealing with mortgage insurance.
LTV stands for loan-to-value ratio. A mortgage that has a high LTV would be one in which the down payment was a low percentage of the sales price and the loan was a high percentage of the sales price. This means the loan is riskier for the lender.
Essentially, the LTV is the percentage of the sales price that is covered by the mortgage.
Calculating the LTV Ratio
If the sales price was $200,000 and the loan amount was $194,000, the LTV ratio is 97%. It would be calculated like so:
$194,000 ÷ $200,000 = 97 %
Loan-to-Value Ratio
Private mortgage insurance (PMI) is insurance paid to a private company by a borrower so that the lender will be insured for the loan amount in case of borrower default.
So, contrary to what it sounds like, private mortgage insurance is not a way to protect the borrower, but instead a way to protect the lender if the borrower stops paying the loan. Make sure your client knows that, since they might think that it is insurance that is protecting them.
PMI exists to allow borrowers who might not qualify for a specific loan to get that loan so they can afford a house. Since they’re riskier borrowers, they will have to pay for the insurance, just in case something happens.Private mortgage insurance is always required when the loan-to-value ratio is higher than 80%. Like the name implies, this type of insurance is provided by private insurance companies, not the lender.
All kinds of factors affect the amount of PMI the borrower will pay, including the borrower’s credit score, the amount of their down payment, the lender, and the market conditions. Not always, but sometimes instead of requiring PMI, some lenders will let borrowers have a loan with a higher interest rate.
Private Mortgage Insurance (PMI)
Mortgage insurance premium (MIP) is the FHA’s equivalent of private mortgage insurance. MIP payments are how FHA insurance is funded.
There are two components to mortgage insurance premiums:
Upfront mortgage insurance premium
Monthly mortgage insurance premium
Every FHA borrower must purchase the insurance. The FHA insurance is insurance on a private loan.
Upfront Mortgage Insurance Premium
The borrower pays 1.75% of the loan amount upfront at closing. This is known as an upfront mortgage insurance premium, or UFMIP for short. All FHA borrowers will pay this premium. The borrower does have the option of rolling the payment into the loan, so the fee is financed along with the mortgage.
Annual Mortgage Insurance Premium
Like private mortgage insurance, if a borrower’s down payment isn’t large enough to give them 20% equity in the property, then they will have to pay an annual mortgage insurance, divided into monthly payments.
One notable difference between MIP and PMI is that MIP payments are not cancelled once a borrower has gained a certain percentage of equity. In fact, if a borrower puts down less than 10% of the loan amount, they will have to pay mortgage insurance premiums for the entire life of the loan. If a borrower puts down more than 10%, then the MIP can be cancelled after 11 years.
Annual mortgage insurance premiums range from 0.45% to 1.05% of the loan amount. That amount is divided by 12 and paid monthly along with the PITI payment (principal, interest, taxes, insurance). The premiums go into an account held by the FHA to repay lost amounts on insured loans in which borrowers default.
MIP Refunds
Certain borrowers may be eligible for a refund on their mortgage insurance. The borrowers must meet all of the following requirements:
They must have acquired the loan after September 1, 1983.
They must have paid an upfront premium at closing.
They must not have defaulted on the loan.
If the loan was originated before January 1, 2001, it must be terminated before the seventh year.
If the loan was originated on or after January 1, 2001, it must be terminated before the fifth year.
Refunds are determined by the FHA commissioner and are based on the number of months for which the loan has been insured.
PMI vs. MIP
Both PMI and MIP function to protect the lender, but as you can see, they do have some slight differences. Take a look at them below!
A Venn diagram that shows the overlap between private mortgage insurance and mortgage insurance premium.
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Mortgage Insurance Premium (MIP)
Borrowers can sometimes get impatient when it comes to paying private mortgage insurance. Besides just waiting until they have paid off enough of the loan, there are options for getting rid of those pesky monthly payments.
Reappraisals
After a few years of paying off a mortgage, there is a decent chance that a borrower’s home has increased in value. Some lenders will consider the new home value when judging whether a borrower needs to pay private mortgage insurance.
If the lender is willing to accept the new home value, a borrower can hire a lender-approved appraiser to give a new appraised value of the property. The additional amount of the money that the home is worth over the original value will be added to the borrower’s equity. If the borrower then has 20% equity in the home, they can request that the private mortgage insurance be cancelled. If the borrower has 22% equity in the home, the servicer is required to eliminate the private mortgage insurance.
While relying on the growth of the real estate market might be enough to increase a home’s value, a borrower can take matters into their own hands, too. Remodeling, putting a pool in the home, building out a new room, or building a guest house are all ways that a home could increase in value. A borrower could request a new appraisal after doing work on their home.
While this technique works for conventional loans, it does not for FHA mortgage insurance premiums. In order to cancel mortgage insurance premium payments, a borrower would have to refinance their loan into a non-FHA-insured loan.
A piggybank jauntily wearing glasses, next to a calculator.
Piggyback Loans
Another way a borrower could avoid paying mortgage insurance is through a kind of second mortgage, called a piggyback loan, or an 80-10-10 loan.
These loans are really two mortgages in one. Instead of giving the borrower one fixed-rate loan at the current market rate, the borrower receives two loans:
One loan for 80% of the sale price at the market rate
One loan for 10% of the sale price at a higher interest rate
For example, suppose a borrower wanted to purchase a home for $150,000. The lender might offer an 80-10-10 loan in which the borrower pays 10% down and receives two loans: one for $120,000 at a 7% interest rate and the other for $15,000 at a 9% interest rate.
The appeal of the 80-10-10 loan is that it does not require the borrower to pay for private mortgage insurance and that, unlike PMI, the interest on the second loan is tax-deductible. PMI is cancelable when the borrower’s equity reaches 20 percent, whereas the second loan of an 80-10-10 mortgage must be paid as any other loan.
An 80-10-10 loan does have lower payments than a comparable single loan, with PMI and greater tax deductions. But if the borrower intends to build equity fast, the PMI loan might save more money in the long run.
Avoiding Mortgage Insurance
