The recent census showed that 60.7% of Canadians pay a mortgage on their homes. A majority of homes in Canada and North America are purchased using mortgages. The number of people taking out mortgages is growing.
A mortgage is a quick and convenient way to own a home if you don’t have the full asking price. However, the lender still requires a new buyer to make a down payment on the house before financing the purchase.
You must pay at least 20% of the purchase price to get a mortgage.
A mortgage is basically a loan. The down payment shows the lender that you are committed to the purchase and are trustworthy to make regular mortgage payments.
What happens when you can’t raise the 20%?
It may happen that during the closing, you don’t have the 20% ready at hand. Perhaps you want to hold on to some cash for making repairs and renovations on the new home or to furnish the rooms.
For whatever reason, if you can’t raise the amount, you have the option of either finding a cheaper house or buying Private Mortgage Insurance (PMI) such as BPMI.
Loan financing is a risky business, which is why lenders insist on insuring their loans. If you can’t raise the principal amount for the mortgage, the lender will force you to buy mortgage insurance. In technical terms, you need PMI to cover mortgages with a loan-to-value ratio of more than 80%.
The risk assessment of the loan is determined by the loan-value ratio (LTV). The figure is calculated by dividing the total sum of the loan by the value of the house and then converting that into a percentage.
For instance, if you need a $180,000 loan to purchase a house worth $200,000, the loan-to-value ratio is 90%. The higher the rate, the higher the risk and interest.
Unlike other types of insurance, mortgage insurance does not protect you. PMI protects the lender from the risk of you defaulting on the loan.
With PMI, borrowers can still take advantage of mortgages by putting down only 5 – 19 percent of the price of the house. The borrower continues to pay for the insurance until they have acquired enough equity on the home and are no longer considered high risk. Typically, you have to pay at least 20% on the value of the house to do away with the PMI.
With the extra insurance cost, you'll end up paying more for the house. The cost of PMI ranges between 0.25-2% of the loan. Typically, many insurers charge between 0.5 to 1% of the loan balance every year. The actual cost may vary depending on the value of the loan, the size of the down payment, credit score, and the loan term.
PMI is an added expense, but most times the alternative costs and effort of taking out other loans to cover the down payment justify the extra spending.
How long you will have to keep paying for PMI and the payment arrangements depends on the type of mortgage insurance you chose to take.
There are four main PMI types, which are discussed below in detail. Learning their differences is primarily a guide to buying mortgage insurance.
BPMI is the most popular type of mortgage insurance. In fact, many people use both terms, PMI and BPMI, interchangeably.
Monthly premiums are paid on BPMI, meaning that the fees are paid along with the mortgage installment. You will continue paying BPMI until you have paid for 22% of the initial price of the house. After that, the lender is obligated to cancel the BPMI so long as you are up to date with your payments.
It generally takes about 9-11 years on average to accumulate a 22% stake in mortgage payments.
You could ask for cancelation after acquiring a 20% equity on the property. However, the lender has to be convinced by satisfactory payment history.
Some lenders allow cancellation of the BPMI sooner if the property appreciates. If the home owner’s equity increases to 25% in a 2 to 5-year appreciation period, or 20% after five years, the lender may discontinue the insurance coverage. In such a case, an appraisal is needed to prove the property’s value.
You can also increase your equity and cancel the insurance early through refinancing. But the refinancing cost must be lower than the premiums for it to make economic sense.
For BPMI, you make the insurance payments yourself. For LPMI, the lender pays for the insurance.
But there is a catch.
You have to repay the lender for the insurance over the entire lifetime of the loan. The cost of PMI insurance is broken down into small installments and added to the mortgage payments.
This type of payment earns higher interests. After the loan, you will have paid slightly more compared to using BPMI.
Unlike BPMI, you can’t cancel the insurance after owning 20% of the house. The insurance payments are built into the loan. As long as you are paying the mortgage, you are also paying for insurance.
Lender-Paid insurance is entirely non-refundable. It also remains unaffected by appreciation or depreciation of the property. The only way to lower the monthly payments is through refinancing.
The only advantage of LPMI over BPMI is that despite the high interest, monthly payments could be lower compared to BPMI installments. This may qualify the borrower for a larger loan.
This type of insurance is also known as single-payment mortgage insurance. In this case, the coverage is paid in one lump sum before the provision of the mortgage.
You can pay it from your pocket or finance it through the mortgage itself.
One benefit of single-premium insurance is that the monthly payments are much lower than in both BPMI and LPMI. Small installments increase the amount of possible loan awarded --so you can borrow more. Plus, you don't have to keep track of the loan-to-value ratio because there is no insurance to cancel.
However, since no portion of the premium is refundable, refinancing or selling the property after a few years could be a loss. If you finance the premium payment using the mortgage, you will have to pay interest on it throughout the loan period. But the interest is not as high as LPMI's interest.
Keep in mind that not every lender is open to single-premium insurance, especially when you want to finance it with the mortgage.
Split-premium mortgage insurance is not very popular with home buyers. It is a hybrid of BPMI and SPMI.
You only pay a part of the insurance premium upfront and clear the rest in monthly installments. This reduces the burden of paying a huge deposit upfront and lowers the monthly payments.
The acceptable upfront payment can be as low as 0.5 of the total loan amount. Monthly premiums depend on loan-to-value ratio without factoring in any financed premiums.
Borrowers generally prefer this type of insurance with a high loan-to-income ratio. In such a case, the high monthly payments of BPMI may reduce the borrower’s qualification for a substantial loan.
Part of the premiums may be refundable if the insurance is terminated. But the initial payment is nonrefundable.
Obviously, the best type of mortgage insurance should be the least expensive in terms of accumulating interest rates. But it is not a straightforward answer to declare one as the best. It all depends on the borrower’s financial situation.
At a glance, BPMI is the best-case scenario. There is no interest on premiums, and you can stop once you have paid off 20% of the property value.
But it doesn’t work for all borrowers. For instance, not everyone is on board with paying full premiums for a long time.
Each type has its pros and cons, and they all make good cases.
To the borrower, it all about trading high-interest rates for lower monthly payments and vice versa. The expected period of ownership and the leverage that the lender has on the borrower may also come into play.
Depending on other available options and financial abilities, some borrowers opt to avoid PMI altogether.
Many homebuyers try to avoid PMI due to the additional cost. But if you think about it, you can either have a home sooner by paying extra for the insurance or continue accumulating the cost of rent or other inconveniences of alternative housing.
It is a win-win situation: you get financing to pay for your home, and the lender is assured of loan repayment.
Besides, you don’t have to pay for insurance throughout the loan period. For instance, with BPMI, you only pay the premiums until you have owned 20% equity of the property.
To many new buyers, PMI provides a financial cushion while transitioning to a new house – which can be expensive. Since you don’t have to make a massive down payment, you can keep some cash to prepare the home and move in.
Are you thinking of getting mortgage insurance? Contact us to find out which companies offer the most competitive prices.