Do First-Time Homebuyers Need Mortgage Insurance in California?
Mortgage Insurance (MI) can set off alarm bells for first-time homebuyers. Homebuyers are not automatically required to pay for mortgage insurance just because they are first-time homebuyers. MI requirements can vary between loan amounts and loan programs.
Mortgage Insurance Triggers
Buyers are generally required to pay for mortgage insurance if their down payment is less than 20% of the purchase price or their loan-to-value (LTV) ratio is more than 80%. Mortgage insurance for conventional loans is known as “Private Mortgage Insurance” (PMI). Mortgage insurance associated with FHA loans is simply called “Mortgage Insurance” (MI).
Private Mortgage Insurance (PMI)
Private Mortgage Insurance (PMI) is for conventional home loans that are not backed or guaranteed by the government. Buyers have three payment options for PMI:
- Monthly PMI: Monthly PMI ranges from 0.1% to over 1% of the loan amount and is paid over the course of 12 months. Depending on the buyer’s LTV, credit, and the loan amount, they can petition out of PMI once they have enough equity. Most lenders require buyers to keep PMI for a minimum of two years irrespective of appreciation.
- Lump Sum or Single Payment PMI: This occurs when a buyer pays a single sum at the close of escrow to permanently cover their PMI with no monthly payments. We typically discourage this option because if a buyer decides to refinance down the road they will not be reimbursed for their lump sum PMI. When homes appreciate quickly, buyers often refinance once their PMI hits its equity cushion of 20%.
- Lender Paid PMI: Buyers have the option to take a higher interest rate in lieu of PMI. Lenders pay the lump sum PMI on behalf of the buyer in exchange for a higher rate. Buyers often think that they get a better deal with lender-paid PMI because they don’t have to make PMI payments. Buyers are really getting stuck with a higher rate for the entire life of their loan. We often discourage buyers from using lender-paid PMI as well.
How to Get Rid of Private Mortgage Insurance
There are three ways to eliminate PMI from a buyer’s conventional loan payment.
Option 1: Refinance
Buyers can refinance into a new loan with no PMI once their property appreciates enough to support a reduced LTV. (Their LTV must be 80% or less.)
Option 2: Paying a loan down to an amount equal to 80% of the original purchase price
Buyers can also eliminate their PMI by paying their loan down if they (1) notify their servicer with their request to eliminate, (2) the buyer has a good payment history, and (3) the buyer is willing to prove to the servicer that their property has not depreciated by getting an appraisal report.
Option 3: Proving the home has appreciated to the point where the LTV is at 75% or less
If a buyer’s loan is backed by Fannie Mae or Freddie Mac, they can eliminate PMI if they (1) notify the servicer of their request to eliminate PMI, (2) the buyer’s loan has been seasoned for two years with a good payment history, (3) the buyer provides a current appraisal with a high enough value to support a 75% LTV. If the buyer’s loan is over 5 years old, the LTV can be 80%.
Mortgage insurance is always required for FHA loans. Buyers pay for MI either as an up-front premium or an annual premium spread out over the course of 12 months.
- Up-front Mortgage Insurance Premium: This is usually 1.75% of the loan amount and is added to the buyer’s total loan.
- Monthly Mortgage Insurance Premium: This is about 0.85% of the total loan amount divided by 12 months and is permanent in most cases.
The Bright Side of Mortgage Insurance
Paying for mortgage insurance might seem like an extra burden for buyers but it does have a bright side. Mortgage insurance gives buyers the opportunity to purchase a house sooner and with less money down. This is a huge bonus for buyers who wouldn’t otherwise have the funds to buy.
The downside, of course, is that buyers will see an increase in their monthly payments due to their mortgage insurance. For most buyers, the opportunity to own far outweighs the extra payments for insurance.
Questions? While this article covers the very basics of mortgage insurance in California, we can provide additional information to those who request it. You can reach us here, or at (925) 855-4491 or [email protected].