If you put less than 20% down, your loan will probably require mortgage insurance (MI). Did you know MI can be paid once, for the full life of the loan? This can be great way to minimize the costs, lower your payment and possibly even increase your purchasing power. There’s a lot to like about Single Premium MI (Single MI, for short).
What is MI?
When you buy a home with less than a 20% down payment, your lender runs the risk that, if you fail to pay and they foreclose, they will likely lose money. Mortgage insurance protects your lender against financial losses in the event of a default and foreclosure.
MI can feel like a raw deal — who wants to pay for insurance that protects someone else? But consider the alternative: without MI, nearly all loans would require at least 20% down, putting homeownership out of reach for many.
If you need or want to put less than 20% down, MI is your friend (or at least frenemy). Given that benefit you see from MI is indirect, the less you can pay for mortgage insurance, the better.
What is a Single MI Premium?
When you pay your MI in a single premium, the one and only time you’ll pay mortgage insurance is the day you close. Your monthly payment will never, for the full life of the loan, include an MI premium.
The Alternative — Monthly MI
The traditional and most common way to pay MI is in monthly installments that are part of your payment. When paid this way, MI will generally drop off of the loan once your loan is scheduled to be paid down to 78% of the purchase price.
Assumption: 5% note rate
Of course the sooner you can get rid of MI the better. In some cases MI can be canceled early. Once you have made at least 24 on-time payments and can show at least 25% equity, your loan servicer may be willing to cancel your MI. You’ll need to make a formal request, following the servicer’s procedure and (quite likely) pay for an appraisal.
Single versus Monthly
So how do single and monthly MI premiums compare? Mortgage insurance premiums change regularly and vary based on a wide number of factors, but here are examples of MI premiums available at the time of this writing.
Assumptions: $300,000 loan amount, standard MI coverage, 780 credit score, 1 borrower, 40% debt-to-income ratio, 97202 zip code.
Single and monthly premiums are both a percent of the loan amount. The single premium is multiplied by the loan amount and due in a lump-sum at closing. The monthly premium due annually. The premium is multiplied by the starting loan amount, divided by 12 and included in the monthly payment.
The “Single vs. Monthly” column shows how long it would take for the monthly premium due to add up to the cost of the single premium. (The single premium by divided by the monthly premium.)
Remember that exact premiums will vary situationally, but pretty consistently, a single premium costs the equivalent of 3 to 4 years of monthly premiums.
Which is Cheaper?
If we assume, worst-case, that you will not be able to cancel your MI early, single MI will nearly always win.
Take the example above with 3% down: a single premium of 1.64% on a $300,000 loan is $4920 . A monthly premium of 0.52% is $130 per month ($300,000 x .0052 / 12). Paid over a worst-case 125 months that equals $16,250. It’s not even a contest. The single premium has the potential to save you over $11,000.
But what if you cancel your MI early? For monthly MI to be cheaper your equity would need to grow from 3% (your initial down payment) to 25% (required to cancel MI) in under 3 years.
If you bought your property for below market value, anticipate rapid appreciation, will be making significant improvements that will add to value or plan on paying your loan down aggressively, you may reach 25% equity that quickly. But, gosh, that would be a lot of equity growth in a short period of time.
After you factor in the cost of an appraisal to prove your equity position (~$700) and the mandatory 24 months of payments, the single MI starts to look like a likely winner.
Beyond the Cost
And beyond the likely cost savings, I can point to many other benefits of single MI:
• Lower Payment – Keeping MI out of your monthly payment, of course, makes your overall payment lower.
• Increased Qualification – If the maximum payment you can qualify for is limiting the amount you can spend, removing MI from your payment should allow you to qualify for a larger loan amount. You’ll usually get the best bang for your buck — qualify for the most house at any given payment — using single MI.
• Buy Sooner – Saving a 20% down payment can be slow going. Buying with less down can mean buying sooner. This can be more than simple delayed gratification if home prices or interest rates (or both) increase while you hold off on buying to save.
• Keep Cash on Hand – Putting less than 20% down may give you the option to hold onto some of your funds for other purposes. With funds you don’t put down, you could make improvements to your new home, pay off other debt or just keep a cash cushion around.
• Known Cost – You may feel confident that you’ll have enough equity to cancel your MI before it is scheduled to drop off… but how soon? Your future home value is an unknown, making the total amount of monthly MI you’ll pay in the meantime an unknown too.
• Simplicity – Paying MI upfront means there’s nothing to cancel later. Nothing to keep in the back of your mind for 2 or more years down the road, no hoops to jump through, no appraisal to arrange.
• Ripping off the Band Aid – Whenever I’m given the option to pay something over time or up-front, I generally prefer to pay up-front. If you’re wired like me, monthly MI may have an intrinsic, conceptual appeal.
What’s the Catch?
If this all sounds great, you may be wondering, “What’s the catch?” It’s not that tough to figure out… the catch is the extra money needed to cover the premium. In addition to paying your down payment and all the usual closing costs, you need to find the money to pay the single MI premium.
Shake the Family Tree
If you’re lucky enough to have potential help from family with your home purchase, consider asking them to pay for single MI. Most loan programs allow gifts from family to go toward loan costs.
At current interest rates, assuming your family chipped in $10,000 and used it to make a bigger down payment, your payment would drop by $50 to $60 per month. Not bad. But in our example above, a $4920 gift would create savings of $130 per month. Over twice the impact on your payment for less than half the money.
Finance Your Single MI
Another option, if you are short on cash, is to finance the single MI premium. Many (but not all) loan programs allow you to roll the cost of your MI premium into your loan amount, so that you don’t have to pay for it in cash. The aggregate amount of your loan and the MI premium cannot exceed (in most cases) 97% of the price of the home you buy.
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