What is MI?When you buy a home with less than a 20% down payment, your lender runs the risk that, if you fail to pay and they foreclose, they will likely lose money. Mortgage insurance protects your lender against financial losses in the event of a default and foreclosure. MI can feel like a raw deal — who wants to pay for insurance that protects someone else? But consider the alternative: without MI, nearly all loans would require at least 20% down, putting homeownership out of reach for many. If you need or want to put less than 20% down, MI is your friend (or at least frenemy). Given that benefit you see from MI is indirect, the less you can pay for mortgage insurance, the better.
What is a Single MI Premium?When you pay your MI in a single premium, the one and only time you’ll pay mortgage insurance is the day you close. Your monthly payment will never, for the full life of the loan, include an MI premium.
The Alternative — Monthly MIThe traditional and most common way to pay MI is in monthly installments that are part of your payment. When paid this way, MI will generally drop off of the loan once your loan is scheduled to be paid down to 78% of the purchase price.
Single versus MonthlySo how do single and monthly MI premiums compare? Mortgage insurance premiums change regularly and vary based on a wide number of factors, but here are examples of MI premiums available at the time of this writing.
Which is Cheaper?If we assume, worst-case, that you will not be able to cancel your MI early, single MI will nearly always win. Take the example above with 3% down: a single premium of 1.64% on a $300,000 loan is $4920 . A monthly premium of 0.52% is $130 per month ($300,000 x .0052 / 12). Paid over a worst-case 125 months that equals $16,250. It’s not even a contest. The single premium has the potential to save you over $11,000. But what if you cancel your MI early? For monthly MI to be cheaper your equity would need to grow from 3% (your initial down payment) to 25% (required to cancel MI) in under 3 years. If you bought your property for below market value, anticipate rapid appreciation, will be making significant improvements that will add to value or plan on paying your loan down aggressively, you may reach 25% equity that quickly. But, gosh, that would be a lot of equity growth in a short period of time. After you factor in the cost of an appraisal to prove your equity position (~$700) and the mandatory 24 months of payments, the single MI starts to look like a likely winner.
Beyond the CostAnd beyond the likely cost savings, I can point to many other benefits of single MI:
• Lower Payment – Keeping MI out of your monthly payment, of course, makes your overall payment lower.
• Increased Qualification – If the maximum payment you can qualify for is limiting the amount you can spend, removing MI from your payment should allow you to qualify for a larger loan amount. You’ll usually get the best bang for your buck — qualify for the most house at any given payment — using single MI.
• Buy Sooner – Saving a 20% down payment can be slow going. Buying with less down can mean buying sooner. This can be more than simple delayed gratification if home prices or interest rates (or both) increase while you hold off on buying to save.
• Keep Cash on Hand – Putting less than 20% down may give you the option to hold onto some of your funds for other purposes. With funds you don’t put down, you could make improvements to your new home, pay off other debt or just keep a cash cushion around.
• Known Cost – You may feel confident that you’ll have enough equity to cancel your MI before it is scheduled to drop off… but how soon? Your future home value is an unknown, making the total amount of monthly MI you’ll pay in the meantime an unknown too.
• Simplicity – Paying MI upfront means there’s nothing to cancel later. Nothing to keep in the back of your mind for 2 or more years down the road, no hoops to jump through, no appraisal to arrange.
• Ripping off the Band Aid – Whenever I’m given the option to pay something over time or up-front, I generally prefer to pay up-front. If you’re wired like me, monthly MI may have an intrinsic, conceptual appeal.