With the recent HUD change in the FHA mortgage insurance premium, Orion’s management thought it would be good to review the basics of mortgage insurance in general. No, this is not the most exciting topic we’ve covered, but it is important since it impacts so many of our broker’s borrowers.

Mortgage insurance as it pertains to obtaining financing to buy a home is not a life insurance policy, nor is it a necessary evil. Lenders, however, will not loan more than 80 percent of the sales price of a home without mortgage insurance on a Freddie Mac or Fannie Mae mortgage unless a second mortgage is arranged. Mortgage insurance protects the lender against losses due to a default by the borrower.

There are many mortgage insurance companies that provide this type of insurance to lenders. Orion selects the mortgage insurer who offer the best rate and program, but it is the borrower who pays the premium. These premiums may be paid either monthly with the mortgage payment or they can be paid in one lumpsum as part of the closing costs, or the lender may pay it in return for an increased interest rate.

Mortgage insurance premiums will effectively add from 0.35 percent to more than 1 percent to the borrower’s interest rate and will usually be paid monthly. The precise premium will be dependent on the type of loan (FHA or conventional), loan-to-value ratio, loan amount, credit scores and whether or not the mortgage is a fixed rate mortgage or an adjustable-rate mortgage.

For the monthly choice, mortgage insurance premiums must be paid for a minimum of two years and then can be canceled after the loan-to-value ratio drops to less than 78 percent.

Unfortunately, the loan-to-value ratio calculation will be based on the price of the home at the time of purchase and not upon the home’s value after two years unless the increase in value of the home is due to remodeling.

To avoid paying a monthly mortgage insurance premium, brokers tell their borrowers that they have two choices. The first would be structuring a first and second mortgage. The first mortgage would typically be for 80 percent of the home’s value and the second mortgage would be a separate mortgage at a higher rate. For example, if a borrower had just 10 percent available for the down payment, an 80/10/10 would involve a first mortgage for 80 percent of the home’s value plus a second mortgage for 10 percent of the home’s value.

The second option involves the little-known fact that in lieu of a monthly premium, mortgage insurance on conventional loans can be paid with one single lump sum payment at the close of escrow. This fee can range from 1 percent to 2 percent of the loan amount, which, for example, translates to $4,000-$8,000 for a loan amount of $400,000. The best choice in mortgage insurance will be dependent on several factors such as how long will you expect this loan to be in place and how much cash is available to cover the closing costs.

Unlike in the case of conventional loans, mortgage insurance is required on all FHA loans, regardless of the down payment, and must be paid for the life of the loan in most cases.

Orion’s AEs are skilled in answering questions on this topic. Please ask!

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