Reinhardt Milam & Fisher, PLLC, Attorneys


		BORROWERS’ GUIDE TO MORTGAGE INSURANCE By Chip Reinhardt Reinhardt Milam & Fisher, PLLC, Attorneys Durham, North Carolina *Index to Contents of this Guide* Do you want to explore ways of saving money on your house mortgage payments? How can you tell whether you will or are now paying for mortgage insurance? What is mortgage insurance anyway, and why do we pay it? How do you get rid of mortgage insurance once it isn’t needed anymore? The Homeowners Protection Act of 1998 The Reinhardt Milam Law Group Mortgage Insurance Download Page Is there a way to avoid mortgage insurance if I’m buying a new house now, or refinancing? What about FHA and VA financing and refunds? Conclusions *Do you want to explore ways of saving money on your house mortgage payments?* One popular way is to consider refinancing at today’s exceptionally low long-term mortgage interest rates. An additional way, whether or not you decide to refinance, is to look into eliminating the cost of mortgage insurance on your current or future mortgage loan. *How can you tell whether you will or are now paying for mortgage insurance?* Here are some general guidelines: 1. If you have an FHA home loan less than 10 years old, then you paid to Uncle Sam a large chunk of mortgage insurance up-front when you took out the loan. On many FHA loans, you also pay with your monthly payments an additional mortgage insurance premium on top of the big up-front premium. 2. If you purchased a home, and financed that purchase using a conventional loan, and if the loan amount was 80% or more of the purchase price of the home, then you are probably paying for mortgage insurance right now through your monthly payments. 3. If you refinanced your home loan, and if the loan amount at the time of the refinance was 80% or more of the appraised value of your home, then, like the new home purchaser, you are probably also paying for mortgage insurance right now through your monthly payments. What is mortgage insurance anyway, and why do we pay it? Over the years, lenders learned that mortgage borrowers who have less than a 20% equity stake in their homes are more likely to default on the debt than a homeowner who has 20% or more equity. Because of this experience, lenders were unwilling to lend money where the borrower was putting up less than a 20% down payment. Since most buyers don’t have the cash to put up a 20% down payment, the mortgage insurance industry came into being. Like all insurance, a mortgage insurance company agrees, in exchange for a premium, to insure lenders against the risk that the borrower might default. The mortgage insurance premium is passed on, either directly or indirectly, to borrowers in the form of higher monthly payments. However, mortgage insurance has long been the proverbial Dr. Jekyll and Mr. Hyde of the residential real estate mortgage industry. The “good Dr. Jekyll” side of mortgage insurance allows borrowers to buy a home even when they don’t have a large amount of money for a 20% or better down payment. The “bad Mr. Hyde” side of mortgage insurance is that, over time, the borrower eventually builds up that 20% equity cushion, but the mortgage insurance premium is STILL being collected from the unsuspecting homeowner. This overpayment of unneeded mortgage insurance premiums costs borrowers in the United States millions upon millions of wasted dollars. You may be one of these borrowers yourself! How do you get rid of mortgage insurance once it isn’t needed anymore? The sad answer to this question is that “it depends.” Except for the Homeowners Protection Act of 1998, which will be discussed later in this article, there aren’t any real regulations or laws at all regarding the borrowers’ ability to terminate unnecessary mortgage insurance premiums. Because there isn’t any automatic termination of mortgage insurance, termination only happens when an informed borrower asks for it and meets the lender’s termination polices. These termination policies vary from lender to lender, and from loan to loan. In general, a lender will allow the borrowers to terminate their mortgage insurance when the borrowers have a good payment history and can prove a 20% equity stake by either a new appraisal or by enough principal reduction of the loan. However, this is a broad generalization. Borrowers who are motivated to save money will contact their own lender, determine that lender’s mortgage termination policies, and then follow through to get rid of their unneeded mortgage insurance premium. The biggest problem with this whole picture is that there is no incentive on the part of the lender to help the borrowers get rid of mortgage insurance after it has outlived its usefulness to the borrowers. The lender is getting default insurance for free (ie, paid for by the borrowers). The borrowers are generally unaware that they even have the right to ask for elimination of unneeded mortgage insurance, and so in blissful ignorance they continue to pay and pay and pay. *The Homeowners Protection Act of 1998* In response to the fundamental unfairness of the current system, Congress passed the Homeowners Protection Act of 1998 (the “HPA”), which was signed by the President and passed into law on July 29, 1998. The full text of the law itself, and the very enlightening Senate Committee report on the law, are available for download on this web site. You will need an Adobe® Acrobat reader to view the downloaded files. (Go to Reinhardt Milam Law Group Mortgage Insurance Download Page) The HPA makes very significant changes with respect to mortgage insurance termination. However, except for some new disclosure rules, the HPA applies ONLY to new conventional mortgage loans which are made ONE YEAR after the date the HPA became law. That is, only new conventional loans made on or after July 29, 1999 will be eligible for the protections of the HPA. Current conventional loans, and new conventional loans made up until July 29, 1999, will, as before, have to rely on informed borrowers initiating a termination process with the lender. The HPA does provide that for all loans with mortgage insurance, including existing loans, the lender must start providing annual notices of the borrowers’ rights to terminate the mortgage insurance and contact information with the lender to process termination requests. It is anticipated that these new notice requirements will soon appear on the borrowers’ annual statement from the lender. Here is a brief summary of the new protections offered by the HPA: 1. Borrowers have the right to cancel mortgage insurance if (a) the borrowers ask for cancellation, (b) the borrowers can prove that they now have at least a 20% equity stake, (c) the borrowers have a good payment history, (d) the loan isn’t exempt or “high risk” as determined by the HPA, and (e) there is no equityline or other subordinate financing. 2. Mortgage insurance will be automatically terminated without action from the borrowers once the loan reaches 78% (77% for “high risk” loans as defined in the HPA) of the lesser of the original sales price or appraised value (as these were used by the lender originally), if payments on the loan are current, and if the loan isn’t otherwise exempt or “high risk.” There is also a cure procedure to bring payments current for the purpose of automatic termination of mortgage insurance. 3. Even if a loan doesn’t qualify for the new cancellation or automatic termination procedures of the HPA, no mortgage insurance premiums will ever be allowed to be collected beyond the half-way point of the original amortization schedule of the loan. That is, if the loan was a 30-year loan, and for some reason didn’t otherwise qualify for cancellation or automatic termination, mortgage insurance would end anyway at the 15-year mark. 4. Nothing in the HPA requires mortgage insurance on a loan, and nothing in the HPA restricts the borrowers and their lender to agree on a shorter cancellation or termination procedure. 5. Closings on new mortgage loans after July 29, 1999 must contain detailed disclosures about borrowers’ rights of cancellation and termination or mortgage insurance. Also, as previously noted, ALL borrowers, both existing, current and new, must receive annual notices of cancellation and/or termination rights available to them. 6. FHA and VA insured loans are exempted from the HPA. *Is there a way to avoid mortgage insurance if I’m buying a new house now, or refinancing?* With a little foresight, and the help of a good mortgage lender, there are some inventive ways to avoid mortgage insurance. We strongly suggest that you consult with your favorite mortgage lender to determine whether or not you can structure mortgage insurance avoidance into your next mortgage loan transaction. There are three basic ways to avoid mortgage insurance: The first, and most obvious way, is for new purchasers to have the 20% cash down payment needed, or for refinances to have an appraisal showing that the new loan is 80% or less of the new appraised value. The second way is a variation of the first, but involves a second mortgage. You borrow on a first mortgage as much of you can, but not going over the 80% of value rule, so that you can avoid mortgage insurance. Then you put up what cash down payment you can and take out a second mortgage for the difference. The plan avoid mortgage insurance, but has two drawbacks: (a) not every mortgage lender will allow second mortgages as part of issuing a first mortgage and (b) interest rates may be higher on the first mortgage and second mortgage, or both. However, since interest is tax-deductible and mortgage insurance is not, that could be a good or bad thing. If you can get a competitive interest rate on the first mortgage, and the first mortgage lender allows a second mortgage so you can avoid the mortgage insurance, then you can adopt a strategy to pay off the second mortgage early with prepayments, but still deduct the interest on both. The third way is what is referred to in the HPA as “lender paid mortgage insurance” (LPMI). The mortgage industry sometimes calls LPMI “tax advantaged” mortgage insurance. What happens is that borrowers are still is required to have mortgage insurance for a loan which exceeds the 80% loan-to-value rules, but the premium for the mortgage insurance is paid directly by the lender. The lender recoups this payment usually by charging a higher interest rate for the mortgage. However, as with the second option, since interest is tax-deductible, it may be worth the extra. The disadvantage of LPMI is that you don’t get any refund, cancellation or termination rights when your loan balances drops below the 80% threshold. *What about FHA and VA financing?* As noted earlier, FHA and VA loans are NOT covered by the HPA. FHA financing is very popular among first-time and lower-income home buyers, because they can buy a home with only 3% of the purchase price paid in a down payment. What happens in an FHA loan is that the US government guarantees that the lender will not suffer a loss in the event of loan default. In effect, the US government acts very much like a private mortgage insurer. There are some very important differences, however. The FHA charges a substantial up-front mortgage insurance premium at the time of closing, but allows the lender to increase the loan amount beyond the 97% threshold to cover this premium in full. Because the loan amount increases to cover the premium, the borrower is actually paying for the mortgage insurance in the form of higher monthly payments. Then, on top of this, the FHA lender charges an additional and separate monthly mortgage insurance premium which is collected on the first 7-10 years of payments. There is no termination or cancellation of the up-front mortgage insurance premium or the monthly mortgage insurance payments, even if the loan balance drops below the 80% threshold used in conventional loans. Instead, the FHA employs a refund procedure if the FHA loan is paid off early. The refund is greatest if the FHA loan is paid off during the first three years. After that, the refund tapers off significantly, until after about 7 years from the time the loan was taken out, there is no longer any refund if the loan is paid off after that time. Therefore, in the event of an FHA loan payoff during the first 7 years of the loan, the borrower is entitled to a refund FROM THE FHA of part of the up-front FHA mortgage insurance premium that was built into the original loan and collected at closing. The borrower will NOT be entitled to any refund of the additional FHA mortgage insurance payments made through the monthly payments. However, as with borrowers’ unawareness of their rights to terminate conventional mortgage insurance, many FHA borrowers are unaware of the FHA mortgage insurance refund when the FHA loan is paid off early. The FHA borrower must seek this refund, which may be a substantial sum of money, only by filling out a refund application and sending it into the FHA. For more information on the refund of FHA insurance premiums, check out the FHA Refund Fact Sheet page as well as the searchable FHA database, where you can see if you have earned or may be entitled to a refund. Although VA loans also involve US government insurance of loan default, VA loans do not have prepaid mortgage insurance like FHA loans. VA loans are made only to active or former members of the US armed services, and can be up to 100% of the purchase price of a home (that is, no down payment). The VA charges a substantial “funding fee” which is similar to the FHA up-front mortgage insurance premium and is also financed into the loan at closing, but which is not at all refundable upon early payoff of the VA loan. *Conclusions* If you have an existing home mortgage loan which is not FHA or VA, and if you pay mortgage insurance as part of your monthly payments, then check your current loan balance against your original home purchase price (if this loan was the one you used to buy the house) or against the appraisal which was used by your lender when the loan was made, to see if you are at or near the 80% loan-to-value threshold. If you’re close, contact your lender to determine its procedures to terminate the mortgage insurance. If the lender informs you that you only need to reduce your loan balance by a few thousand dollars, consider taking out an equityline mortgage with your bank to raise the money to pay down your mortgage loan and get rid of the unproductive mortgage insurance. If your lender allows you to reach the 80% threshold by securing a new and higher appraisal, and you think your house has appreciated substantially, then consider spending the money for a new appraisal and getting rid of mortgage insurance. If you’re getting ready to take out a new loan for purchase or refinance, consider the impact of mortgage insurance if you’re going to borrow more than the 80% loan-to-value ratio. Explore with your lender available mortgage insurance avoidance techniques. Even if you’re not ready to get rid of mortgage insurance by these methods, remember that thanks to the new HPA, you will be receiving annual disclosures from your lender describing your continuing rights to do this. If you have paid off an FHA loan within the last five years, either by sale of your house or refinance to a conventional or VA loan, and if you didn’t receive any refund from the FHA of the unused up-front mortgage insurance premium, then find your original closing statement for when the paid-off FHA loan was originally taken out to see if you in fact paid for up-front FHA mortgage insurance. If you see that you did, then check out the FHA fact sheet page as well as the online searchable FHA database, where you can search the FHA database to see if you have earned or may be entitled to a refund.