Mortgage Insurance In the Post-Crisis Market: Do You Know Your Options?

June 28, 2010, Revised August 14, 2010

I decided recently to take a look at private mortgage insurance (PMI) in the post-crisis market: how it differs from the pre-crisis market; the different payment options available to mortgage borrowers today, and how to choose between them; and why the PMI market is rigged against borrowers.  

Crisis-Induced Changes in PMI

The universal rule is that private mortgage insurance is required on conventional loans (those not insured or guaranteed by the Federal Government) whenever the borrower’s down payment on a home purchase, or equity in the property on a refinance, is less than 20%. This was also the rule before the crisis, but the rule was often violated in connection with sub-prime mortgages. Today, there are no such exceptions. Further, declines in property values since 2006 have eroded homeowner equity, making mortgage insurance mandatory in an increasing proportion of refinances.

PMI companies have suffered horrendous losses in recent years, in response to which they have increased their premiums, especially on riskier transactions, and tightened their eligibility requirements. For example, borrowers with credit scores below 660 are generally ineligible. The insurers, however, offer the same insurance premium payment options as before the crisis.

Mortgage Insurance Payment Options 

PMI companies offer numerous premium plans, but only three are worth considering. These are:

*Monthly Premium: The borrower pays the same amount every month until the loan balance is paid down to 78-80% of the initial property value, at which point the payments cease.

*Single Financed Premium With Rebates: The borrower makes one payment upfront which is added to the loan amount, but receives a partial rebate if the loan is terminated within 5 years.

*Single Financed Premium Without Rebates:  The same but there are no rebates.

The monthly premium plan is the most widely used by far, in large part because most borrowers don’t know they have other options. Why most borrowers are not aware of their options is discussed in Mortgage Insurance in the Post-Crisis Market: Why Is the Market Rigged Against Borrowers?  

Mortgage Insurance Premiums In the Current Market 

I shopped premiums at the 6 PMI companies on a “plain vanilla” mortgage. It was a fixed-rate 30-year fully-amortizing and fully documented mortgage used to purchase a single-family property in California as a primary residence by a borrower with a FICO score of 720 making a down payment of 10%. Since there were differences in the premiums quoted on this mortgage by the different PMI companies, I selected the most common premium for each of the three options. These were .62%/12 for the monthly premium, 2.20% for the single premium with rebates, and 1.40% for the single premium without rebates.  

Note that these premiums are not much different from those shown in Sample Mortgage Insurance Premiums which were compiled in September, 2005. The difference is that in 2005, the quoted premiums were available pretty much to all comers, whereas in 2010 the quoted premiums were limited to borrowers with the features described immediately above.

Impact of Different PMI Premium Plans on Payments

The single premium plans generate a much lower monthly payment increase than the monthly plan. For example, on a 30-year loan of $90,000 at 5%, the payment without insurance is $483.14, the monthly insurance premium is $46.50, and the total payment is $529.64. The single financed premium with rebates increases the loan amount to $91,980, increasing the payment from $483.14 to $493.77. The single financed premium without rebates increases the loan amount to $91,260 and the payment to $489.91. In other words, the payment increase on this policy is $6.77 compared to $46.50 on the monthly premium policy.

But as I constantly remind borrowers, payments aren’t everything. The loan balance on the single premium plans is larger when the loan is paid off, which increases its cost over the years the borrower has the policy. Unless the payment difference between the options significantly affects the borrower’s ability to afford the loan, the best premium plan is the one with the lowest total cost over the period the borrower expects to have the mortgage.  

Factors Affecting the Total Cost of Mortgage Insurance

The total cost of the different options depends on how long the borrower expects to have the mortgage, how rapidly the property value appreciates, the borrower’s tax rate, whether or not the insurance premium is deductible, and the borrower’s investment rate – the interest loss on monies paid out. In general, a high expected appreciation rate and high tax rates when MI premiums are deductible favors the monthly premium, whereas a long expected mortgage life and high investment rate favor the single-premium.

But borrowers should not rely on generalizations, because every transaction is different. Chuck Freedenberg and I developed a new calculator, Future Value Calculator: Comparing Mortgage Insurance Options (14d) that allows a user to find the cost of the different options in his or her particular case. I used the calculator to test many different combinations of the factors discussed above, and found something interesting. In some cases the monthly premium policy had the lowest cost, and in other cases the single premium without rebates had the lowest cost, but in no case did  the single premium with rebates have the lowest cost. It appears safe for borrowers to avoid this option, which seems to be over-priced.

Borrowers who are aware of the options can ask for premium quotes and test them using the calculator. If they don’t ask, it is very unlikely that the information will be volunteered. This suggests that there is something seriously amiss in the ways in which mortgage insurance is marketed and delivered, which is discussed in Mortgage Insurance in the Post-Crisis Market: Why Is the Market Rigged Against Borrowers?  

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