Chapter 16: Mortgage Insurance and Risk Mitigation
Mortgage insurance (MI) is a critical risk mitigation tool
used in mortgage lending, especially for loans with low down payments or higher
risk profiles. This chapter covers types of mortgage insurance, eligibility,
costs, cancellation, and how it helps lenders manage risk.
Section 1: Purpose of Mortgage Insurance
- Protects
lender against borrower default.
- Enables
borrowers to qualify for loans with down payments less than 20%.
- Helps
expand homeownership opportunities.
Section 2: Types of Mortgage Insurance
2.1 Private Mortgage Insurance (PMI)
- Required
for conventional loans when LTV exceeds 80%.
- Provided
by private companies (e.g., MGIC, Radian).
- Types:
- Borrower-paid
monthly premiums.
- Single
premium (paid upfront).
- Split
premium (combination of upfront and monthly).
- PMI
rates vary based on credit score, LTV, and loan type.
2.2 FHA Mortgage Insurance Premium (MIP)
- Mandatory
for FHA loans.
- Includes:
- Upfront
MIP (UFMIP) – usually 1.75% of loan amount, paid at closing or financed.
- Annual
MIP – paid monthly as part of mortgage payment.
- Duration
depends on loan amount, LTV, and loan term.
2.3 VA Funding Fee
- Not
technically insurance, but a one-time fee to support the VA loan program.
- Fee
varies based on down payment and service status.
- Can
be financed into the loan.
2.4 USDA Guarantee Fee
- Upfront
and annual fees to support USDA loans.
- Similar
in function to VA funding fee.
Section 3: Eligibility for Mortgage Insurance
- Required
when LTV exceeds 80% (for conventional).
- FHA
loans require MIP regardless of down payment.
- Some
lenders offer “Lender Paid MI” where lender pays premiums, but cost is
usually recouped in higher interest rates.
Section 4: Mortgage Insurance Cancellation
4.1 PMI Cancellation Rules (Conventional)
- Borrower
may request cancellation when LTV reaches 80% based on original value.
- Automatic
termination at 78% LTV (per Homeowners Protection Act).
- Borrower
must be current on payments and have good payment history.
4.2 FHA MIP Cancellation
- For
loans originated after June 3, 2013:
- MIP
is required for entire loan term if LTV >90%.
- For
LTV ≤ 90%, MIP is required for 11 years.
- No
automatic cancellation; must refinance to remove.
Section 5: Impact of Mortgage Insurance on Borrowers
- Adds
to monthly mortgage payment.
- Increases
overall loan cost.
- May
affect borrower’s debt-to-income ratio.
Section 6: Calculating Mortgage Insurance Costs
- PMI
varies, commonly 0.3% to 1.5% of loan amount annually.
- FHA
UFMIP example: $200,000 × 1.75% = $3,500 upfront.
- Monthly
MIP depends on loan term, LTV, and base loan amount.
Section 7: Risk Mitigation Beyond Mortgage Insurance
- Underwriting
overlays and stricter guidelines.
- Higher
credit score requirements.
- Requiring
reserves or larger down payments.
- Use
of credit enhancements or loan loss reserves.
Section 8: Case Studies
Case 1: Conventional Loan with 90% LTV
- Borrower
required to pay monthly PMI.
- PMI
cancelled when LTV hits 78%.
- Borrower
refinances after 5 years to remove PMI sooner.
Case 2: FHA Loan with 3.5% Down Payment
- UFMIP
financed into loan.
- Monthly
MIP paid until loan payoff or refinance.
- Borrower
informed of long-term MI cost.
Final Notes
- Mortgage
insurance is essential for protecting lenders and enabling low down
payment loans.
- Borrowers
must understand costs and cancellation policies.
- Underwriters
must verify MI requirements and ensure proper disclosure.
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