Peter G. Miller
OurBroker®

New guidelines expected to start in March will reduce the cost of private mortgage insurance by $1,000 or more for many purchasers. But will the new guidelines also lead to higher interest costs?

Few people buy homes with 20 percent down, especially first-time purchasers. Such buyers would be frozen out of the market if lenders rigidly required 20 percent up-front, the standard down payment for so-called "conventional" financing.

Lenders want buyers to put down 20 percent because if something goes wrong and the home must be foreclosed, there's lots of room between the amount advanced by the lender and the value of the property. Even if the property sells for less than the borrower's purchase price, it's likely that with 20 percent down the lender will still be able to recover its loan money in full.

But, since not everyone has enough cash for a 20 percent down payment, lenders have come up with an alternative: mortgage insurance, known generally as "MI" or "PMI." Instead of putting a pile of cash on the table at closing, borrowers can instead get insurance and buy a home with 15, 10, 5, 3, and sometimes nothing down.

Mortgage insurance programs can be divided into two categories, federal and private. The Federal programs include financing insured under the FHA and VA programs. Private mortgage insurance is offered by eight companies, all of which are members of a trade association, the Mortgage Insurance Companies of America, (MICA).

Mortgage insurance programs are profoundly important. In 1997, says MICA, 840,000 loans were backed by FHA, 255,000 were issued under the VA program, and 975,000 were insured by private companies.

FHA borrowers pay an up-front fee as well as a monthly insurance premium, while VA borrowers pay an up-front "funding fee." With private mortgage insurance, borrowers can pay with a single up-front premium or monthly payments.

In general, private mortgage insurance premiums work like this: less down means more insurance, more down means less insurance coverage. Seen another way, if you buy with 3 percent down you need more insurance than if you purchase with 15 percent down. If you buy with 20 percent down, forget it, mortgage insurance is not required.

Now, Fannie Mae has announced is that it has studied the matter and decided that while mortgage insurance is still necessary, coverage levels can be reduced. For example, if you buy a home with 5 percent down, 30 percent mortgage insurance coverage had been required. Now the necessary level of coverage is being reduced to 25 percent.

While such a change seems minor, someone borrowing $100,000 and paying monthly mortgage insurance premiums might save $110 a year, or about $1,100 in the first 10 years of the loan. That's real money.

If the required level of insurance coverage drops it seems reasonable to assume that smaller premiums will follow. As well, lower MI fees should mean more competition for the FHA and VA programs, inherently good news for consumers.

But if insurance coverage is reduced will mortgage financing be regarded as more risky? And, if risk goes up, will investors -- the people and institutions who supply mortgage money -- want more interest?

An "okay" by Fannie Mae is a powerful measure of acceptance, but what if investors still see additional risk? Let's say investors are largely convinced -- but not entirely, and rates rise 1/8th of a percent. For a $100,000 mortgage that's an annual cost increase of $125.

The new Fannie Mae guidelines essentially return us to the MI coverage levels required until 1994. We'll see less income for MI companies and lower costs for consumers. Whether we'll also see somewhat higher interest rates is a matter to watch.

Also See: "Homeowners Protection Act" To Limit PMI Overcharges

Question Of The Week

Q We've bought a home with FHA financing and will settle in a few weeks. The sellers have now decided they don't want to pay certain loans fees. What are our options?

A This is a settled matter. You have an agreement with the owners which explains who pays what at closing. Once the agreement is in place, it can only be changed with the mutual consent of both parties.

For specifics, speak with your broker or attorney.

Weekly Resource

The Agriculture Department has several programs for low and very-low income buyers wishing to purchase property in rural areas. For details, including information for programs with nothing down, see the Single Family Housing home page.

Published: January 26, 1999

Use of this article without permission is a violation of federal copyright laws.

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Editor's Note: This article reflects the opinions of Peter Miller only and not necessarily the views of this or any other publication, organization or Website owner.

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