Several years ago, the mortgage industry conducted research which conclusively determined that people who have mortgages with loan-to-values (LTVs) of above 80% have a higher likelihood of default than those who have mortgages with LTVs at or below 80%. When this industry research became conclusive, the mortgage industry found itself at a fork in the road.
On the one hand, the industry could continue conducting business as usual. But the risk! The risk was far greater than the risk that it realized it was previously enduring. On the other hand, the industry could simply cap mortgages’ maximum LTVs to 80%. But that would prevent a multitude of people from participating in the American dream of homeownership. Let’s face it. Not many people have 20% or more to put down when buying a home. So what to do? What to do? What to do? What ultimately happened was that a third pathway was forged. The creation of the Mortgage Insurance Industry.
Private mortgage insurance, or PMI to which it is referred, is only and always affiliated with conventional mortgage loans. Just about every conventional loan with an LTV of above 80% requires PMI. PMI does nothing for the borrower, aside from allowing him or her to have a conventional mortgage with less than a 20% down payment. And, although it may provide a means to the desired end, it’s not typically cheap. Even with stellar credit, a $250,000 mortgage loan, with 5% down, could easily require a monthly PMI payment in excess of $175.
Although, in just about all cases, mortgage servicers will eventually delete a borrower’s PMI premium, imagine how nice it will be when you can offer your conventional borrowers options to avoid paying PMI even though they lack a 20% down payment! Therefore, and without further ado, please allow me to introduce you to three creative PMI alternatives:
- Piggyback financing
- Lender-paid PMI
- Financed MI
Piggyback financing uses two simultaneously-originated mortgages to eliminate the need for PMI. The first mortgage is the primary loan and, as such, it must be originated at or below 80% LTV thereby negating the need for PMI. Next, the loan originator arranges for a second mortgage, typically a home equity loan, which supplements the difference between the first mortgage and the borrower’s down payment.
Consider the following example. A customer wants to purchase a home for $312,500 but only has $24,000 to use as a down payment equating to 7%. Although the customer would be able to qualify solely by considering the principal and interest (P&I) and escrow payments, by increasing the total mortgage payment to include the $175 monthly PMI premium, the customer’s debt-to-income ratios (DTIs) surpass the product’s DTI tolerances. So what now? Say goodbye and move on to a more qualified borrower?
The resourceful mortgage loan originator would be quick to suggest a piggyback loan scenario solution. In doing so, instead of a $288,500 mortgage and a $175 monthly PMI premium, the borrower would settle on a $250,000 first mortgage at 80% LTV (thereby avoiding the need for PMI) in addition to a second mortgage for $38,500 to supplement the difference between the first mortgage’s balance and the borrower’s 7% down payment.
By pursuing the piggyback financing option, the borrower is able to afford his mortgage payments, avoids having to pay PMI, and builds equity faster because, in all likelihood, the home equity loan would be at a 15-year term.
The only challenge would be finding a second mortgage lender to lend the home equity loan under these parameters. But, once found, the solution’s value becomes clear.
Another option to avoid paying a monthly PMI premium with less than a 20% down payment would be to explore whether the lender offers lender-paid PMI. Lender-paid PMI takes the form of the lender agreeing to pay the PMI on behalf of the borrower in turn for charging the borrower a higher interest rate. And, even though the borrower’s rate is higher, the higher payment amount due to the higher interest rate should not even come close to what the monthly PMI premium would otherwise be.
Additionally, and because the interest rate on which the borrower settles is higher than it would have otherwise been, the borrower’s income tax deduction could be higher since he or she is paying more interest than he or she otherwise would have. This, of course, assumes that the mortgage’s interest is tax deductible. Never give definitive tax advice unless you are trained and certified to do so. It’s best and safest to always refer your customer to a qualified tax professional or the Internal Revenue Service (IRS).
With a down payment of at least 10%, financed MI can certainly prove to be a much better option than paying a monthly PMI premium. When utilizing financed MI, a one-time PMI premium is financed into the borrower’s loan amount thereby negating the need for him or her to pay a monthly PMI premium.
Financed MI typically results in an overall monthly expenditure that’s less than paying a monthly PMI premium or second mortgage payment, a higher tax deduction since the loan’s original balance is higher than it would otherwise have been resulting in more interest spent (always refer your customer to a qualified tax professional or the IRS), and, in many cases, if the borrower was to sell his or her home or refinance the mortgage within the loan’s first seven years, many PMI companies would issue the borrower a pro-rated refund of the financed PMI premium.
Talented and successful mortgage loan originators know of all possible solutions to their customers’ needs and wants, just as competent physicians know how to accurately diagnose and properly treat their patients. Mortgage loan originators who take the time to learn about all options and solutions surpass their competition and ultimately wind up being seen as the “go-to” solution to home borrowers’ needs.