Tag Archives: refinance

Temporary Interest Rate Buydowns

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photo by Tobias Baur

I was quoted in This Strategy to Cut Mortgage Rates is Becoming Popular in Bay Area — but There are Pitfalls in the San Francisco Chronicle (paywall). It opens,

When first-time buyers Rachel Shatto and Randy Nelson purchased a home in Oakland in May, they negotiated an interest rate buydown that effectively lowered their mortgage rate, and thus their monthly payment, for the first two years.

Although the seller made a lump-sum payment for the short-term rate decrease at closing, they increased their purchase price to compensate for it. This temporary rate buydown left them with more cash to pay for repairs and improvements the first couple of years, Shatto said.

Both temporary buydowns, which effectively lower the rate for one to three years, and permanent ones, which reduce it for the life of the loan, have become more popular since interest rates started soaring last year.

In June, 2.8% of 30-year fixed-rate loans funded by Freddie Mac had temporary buydowns, up from near zero a year ago but down from a peak of 7.6% in December 2022, shortly after rates spiked above 7% for the first time in more than two decades. After dipping as low as 6.14% in February, they surged above 7% again in August and now stand at 7.18%.

Buydowns are most common on new homes. When rates rise, builders frequently offer temporary or permanent buydowns as one of several incentives buyers can choose from.

A survey of builders in August asked what has been the most effective way to get buyers off the sidelines. The No. 1 answer, cited by 69% of respondents, was mortgage-rate buydowns, said Ali Wolf, chief economist with Zonda, a new-home data and consulting firm that did the survey. Only 22% said price cuts.

“When they lower prices, buyers already under contract at a higher price tend to cancel their contracts and it becomes a vicious cycle,” Wolf said.

Landsea Homes is offering buydowns on select homes in select communities including the newly opened Alameda Marina. “We are only able to offer them on homes that we can deliver within 30 to 60 days,” said Josh Santos, Landsea’s Northern California division president. “I’d say 75% of our buyers in the last 60 days” chose buydowns in lieu of other incentives such as options, upgrades or homeowners association dues.

Some sellers are also offering them on existing homes that have been sitting for a while.

Whether they make sense for buyers depends on myriad factors including their overall finances, the cost versus savings, how long they plan to stay in the home, whether they spend or invest their monthly savings, who’s actually paying for them, and future interest rates, the last of which is unknowable.

Borrowers should make sure they understand how buydowns work, the potential pitfalls and other ways to save money on a mortgage.

How permanent buydowns work

A permanent rate buydown is fairly straightforward. The buyer pays fees, called discount points, to reduce the interest rate — and therefore the monthly payment — forever.

One discount point equals 1% of the loan amount. To lower the note rate by 1 percentage point, a buyer today might pay around three points to four points. This cost can vary widely depending on the day, the lender and other factors, said Westin Miller, branch manager with Pinnacle Home Loans in Santa Rosa.

To figure out how long it would take for your monthly savings to equal the points paid, divide the total upfront fee by your monthly mortgage payment (or plug the numbers into an online mortgage discount points calculator).

Suppose a buyer can permanently lower the rate on a $700,000 mortgage to 6.5% from 7.5% by paying three points, or $21,000. That would lower the monthly payment by about $470 a month.

Divide $21,000 by $470 you get 36 months, which is the breakeven point. A borrower who kept the loan for more than three years would come out ahead. The longer it was kept, the bigger the benefit.

If a buyer knew for sure that rates were coming down soon, it might be better to take the higher rate with no points and refinance when rates drop, although refinancers will generally have to pay some closing costs again.

“If you are going to sell or refinance in a few years, paying points doesn’t make sense,” said Jeff Ostrowski, a Bankrate analyst.

Some buyers get permanent buydowns because they need a lower rate to qualify for a loan, said Jason Barnes, mortgage sales supervisor with U.S. Bank in Campbell.

Buyers pay for permanent buydowns, but in a slow market they might be able to negotiate a credit from the seller at closing to help pay for it.

How temporary buydowns work

With a temporary buydown, the borrower typically takes out a 30-year fixed-rate loan but makes payments based on a lower interest rate during the first one, two or three years in exchange for a one-time payment that is deposited into an escrow account at closing.

The upfront payment is about equal to the interest savings during the discount period.

During this period, the borrower makes payments at the lower rate and the mortgage servicer draws from the account to make up the difference. At the end of the discount period, the borrower makes the full payment.

Suppose the note rate is 7.5%. With a 1/0 buydown, the buyer makes payments based on a 6.5% rate the first year and 7.5% in years two through 30.

With a 2/1 buydown the borrower pays at 5.5% the first year, 6.5% the second year and 7.5% in all remaining years.

Three-year buydowns are available but not too popular because of the steep price.

The borrower generally must qualify for the loan based on the note rate stated in the loan agreement, in this case 7.5%.

Most lenders require sellers to pay for temporary buydowns, meaning the cost comes out of their proceeds at closing. If the buyer has no choice between a true seller-paid buydown and a lower price, there’s little reason not to take the buydown.

In competitive situations, buyers might need to increase their purchase price to cover some or all of the buydown payment, in which case they’re paying for it indirectly. Here the cost/benefit analysis gets more complicated.

A real-life example

When Shatto and Nelson bought their “cute little 1927 Tudor revival” in Oakland, they took out a 30-year loan with a 2/1 buydown from LaSalle Mortgage, Shatto said. They’re paying based on a rate of 4.125% for the first year, 5.125% the second and 6.125% thereafter.

Over the first two years, the buydown will save them $15,470 in interest, which was the cost of the buydown.

Although the seller paid for the buydown, the buyers paid a higher price to compensate, said their agent Lindsay Ferlin of Red Oak Realty.

Did they make a good deal? Here’s one way to look at it.

They paid $866,000 and, with a 20% down payment, and borrowed $692,800. Had they not used a buydown and paid $15,470 less, they would have borrowed $680,424 with 20% down.

With the higher loan amount, they’d repay an extra $27,071 over 30 years — consisting of $14,695 in interest and $12,376 in principal. But during the first two years, they’d save a total of $15,470, and most people don’t keep a mortgage for 30 years.

“Outside of a few cases, this does not have a significant economic benefit for borrowers,” said David Reiss, a professor of real estate law at Brooklyn Law School. “It’s a little bit of smoke and mirrors. I don’t think it improves their financial condition other than in a few cases where you have a low income in the present and expect it to grow significantly after a couple of years.”

Rising Rates and The Mortgage Market

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The Urban Institute’s Housing Finance at a Glance Chartbook for March focuses on how rising interest rates have been impacting the mortgage market. The chartbook makes a series of excellent points about current trends, although homeowners and homebuyers should keep in mind that rates remain near historic lows:

As mortgage rates have increased, there has been no shortage of articles explaining the effect of rising rates on the mortgage market. Mortgage rates began their present sustained increase immediately after the last presidential election in November 2016, 20 months ago. Enough data points have become available during thisperiod that we can now measure the effects of rising rates. Below we outline a few.

Refinances: The most immediate impact of rising rates is on refinance volumes, which fall as rates rise. For mortgages backed by Fannie Mae and Freddie Mac, the refinance share of total originations declined from 63 percent in Nov 2016 to 46 percent today (page 11). For FHA, VA and USDA-insured mortgages, the refinance share dropped from 44 percent to 35 percent. In terms of volume, Fannie Mae and Freddie Mac backed refinance volume totaled $390 billion in 2017, down from $550 billion in 2016. For Ginnie Mae, refi volume dropped from $197 billion in 2016 to $136 billion in 2017. Looking ahead, most estimates for 2018 point to a continued reduction in the refi share and origination volumes (page 15).

Originator profitability: Of course, less demand for mortgages isn’t good for originator profitability because lenders need to compete harder to attract borrowers. They do this often by reducing profit margins as rates rise (conversely, when rates are falling and everyone is rushing to refinance, lenders tend to respond by increasing their profit margins). Indeed, since Nov 2016, originator profitability has declined from $2.6 per $100 of loans originated to $1.93 today (page 16). Post crisis originator profitability reached as high as $5 per $100 loan in late 2012, when rates were at their lowest point.

Cash-out share: Another consequence of falling refinance volumes is the rising share of cash-out refinances. The share of cash-out refinances varies partly because borrowers’ motivations change with interest rates. When rates are low, the primary goal of refinancing is to reduce the monthly payment. Cash-out share tends to be low during such periods. But when rates are high, borrowers have no incentive to refinance for rate reasons. Those who still refinance tend to be driven more by their desire to cash-out (although this doesn’t mean that the volume is also high). As such, cash-out share of refinances increased to 63 percent in Q4 2017 according to Freddie Mac Quarterly Refinance Statistics. The last time cash-out share was this high was in 2008.

Industry consolidation: A longer-term impact of rising rates is industry consolidation: not every lender can afford to cut profitability. Larger, diversified originators are more able to accept lower margins because they can make up for it through other lines of business or simply accept lower profitability for some time. Smaller lenders may not have such flexibility and may find it necessary to merge with another entity. Industry consolidation due to higher rates is not easy to quantify as firms can merge or get acquired for various reasons. At the same time, one can’t ignore New Residential Investment’s recent acquisition of Shellpoint Partners and Ocwen’s purchase of PHH. (5)

FinTech Disrupting The Mortgage Industry

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photo by www.cafecredit.com

photo by www.cafecredit.com

Researchers at the NY Fed have posted The Role of Technology in Mortgage Lending. There is no doubt that tech can disrupt the mortgage lending business much as it has done with others. The abstract reads,

Technology-based (“FinTech”) lenders increased their market share of U.S. mortgage lending from 2 percent to 8 percent from 2010 to 2016. Using market-wide, loan-level data on U.S. mortgage applications and originations, we show that FinTech lenders process mortgage applications about 20 percent faster than other lenders, even when controlling for detailed loan, borrower, and geographic observables. Faster processing does not come at the cost of higher defaults. FinTech lenders adjust supply more elastically than other lenders in response to exogenous mortgage demand shocks, thereby alleviating capacity constraints associated with traditional mortgage lending. In areas with more FinTech lending, borrowers refinance more, especially when it is in their interest to do so. We find no evidence that FinTech lenders target marginal borrowers. Our results suggest that technological innovation has improved the efficiency of financial intermediation in the U.S. mortgage market.

The report documents the significant extent to which FinTech firms have already disrupted the primary mortgage market. They also predict a whole lot more disruption coming down the pike:

Going forward, we expect that other lenders will seek to replicate the “FinTech model” characterized by electronic application processes with centralized, semi-automated underwriting operations. However, it is unclear whether traditional lenders or small institutions will all be able to adopt these practices as these innovations require significant reorganization and sizable investments. The end result could be a more concentrated mortgage market dominated by those firms that can afford to innovate. From a consumer perspective, we believe our results shed light on how mortgage credit supply is likely to evolve in the future. Specifically, technology will allow the origination process to be faster and to more easily accommodate changes in interest rates, leading to greater transmission of monetary policy to households via the mortgage market. Our findings also imply that technological diffusion may reduce inefficiencies in refinancing decisions, with significant benefits to U.S. households.

Our results have to be considered in the prevailing institutional context of the U.S. mortgage market. Specifically, at the time of our study FinTech lenders are non-banks that securitize their mortgages and do not take deposits. It remains to be seen whether we find the same benefits of FinTech lending as the model spreads to deposit-taking banks and their borrowers. Changes in banking regulation or the housing finance system may affect FinTech lenders going forward. Also, the benefits we document stem from innovations that rely on hard information; as these innovations spread, they may affect access to credit for those borrowers with applications that require soft information or borrowers that require direct communication with a loan officer. (37-38)

I think that the author’s predictions are right on target.

 

The Importance of Mortgage Data

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Senate Bill 2155 is looking like it will be enacted and reduce the amount of data collected pursuant to the Home Mortgage Disclosure Act. The Federal Reserve Bulletin includes a report that demonstrates just how useful that data is, Residential Mortgage Lending in 2016: Evidence from the Home Mortgage Disclosure Act Data. Key findings of the report include,

1. The number of mortgage originations in 2016 rose 13 percent, to 8.4 million from 7.4 million in 2015. For loans secured by one- to four-family properties, growth was strong in both home-purchase originations—which increased to 4.0 million from 3.7 million in 2015—and refinance originations—which increased to 3.8 million from 3.2 million in 2015.

2. Black and Hispanic white borrowers increased their share of home-purchase loans for one- to four-family, owner-occupied, site-built properties in 2016, the third consecutive annual rise for both groups. The HMDA data indicate that 6.0 percent of such loans went to black borrowers, up from 5.5 percent in 2015, while 8.8 percent went to Hispanic white borrowers, up from 8.3 percent in 2015. The share of home-purchase loans to low- or moderate-income (LMI) borrowers decreased to 26 percent in 2016 from 28 percent in 2015.

3. The average value of home-purchase loans rose 3.2 percent in 2016, to $257,000, with similar increases for loans made to borrowers of different racial and ethnic groups. The average value of home-purchase loans to Hispanic white borrowers remained well below the 2006 peak, while the averages for Asian, black, and non-Hispanic white borrowers were all above their 2006–07 peaks.

4. Black and Hispanic white borrowers continued to be much more likely to use nonconventional loans (that is, loans with mortgage insurance from the Federal Housing Administration (FHA) or guarantees from the Department of Veterans Affairs (VA), the Farm Service Agency (FSA), or the Rural Housing Service (RHS)) than conventional loans compared with other racial and ethnic groups. In 2016, among home-purchase borrowers, 69 percent of blacks and 60 percent of Hispanic whites took out a no-conventional loan, whereas about 35 percent of non-Hispanic whites and just 16 percent of Asians did so.

5. The share of mortgages originated by non-depository, independent mortgage companies has increased sharply in recent years. In 2016, this group of lenders accounted for 53 percent of first-lien owner-occupant home-purchase loans, up from 50 percent in 2015. Independent mortgage companies also originated 52 percent of first-lien owner–occupant refinance loans, an increase from 48 percent in 2015. For the first time since at least 1995, non-depository, independent mortgage companies accounted for a majority of each of these types of loans. (2-3)

 It is important that HMDA data continue to provide a reliable overview of the mortgage market so that changes in the market can be identified and policies can be modified to respond to them. It remains to be seen just how much Senate Bill 2155 will reduce the usefulness of HMDA data. Time will tell.

Nonbanks and The Next Crisis

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Researchers at the Fed and UC Berkeley have posted Liquidity Crises in the Mortgage Markets. The authors conclusions are particularly troubling:

The nonbank mortgage sector has boomed in recent years. The combination of low interest rates, well-functioning GSE and Ginnie Mae securitization markets, and streamlined FHA and VA programs have created ample opportunities for nonbanks to generate revenue by refinancing mortgages. Commercial banks have been happy to supply warehouse lines of credit to nonbanks at favorable rates. Delinquency rates have been low, and so nonbanks have not needed to finance servicing advances.

In this paper, we ask “What happens next?” What happens if interest rates rise and nonbank revenue drops? What happens if commercial banks or other financial institutions lose their taste for extending credit to nonbanks? What happens if delinquency rates rise and servicers have to advance payments to investors—advances that, in the case of Ginnie Mae pools, the servicer cannot finance, and on which they might take a sizable capital loss?

We cannot provide reassuring answers to any of these questions. The typical nonbank has few resources with which to weather these shocks. Nonbanks with servicing portfolios concentrated in Ginnie Mae pools are exposed to a higher risk of borrower default and higher potential losses in the event of such a default, and yet, as far as we can tell from our limited data, have even less liquidity on hand than other nonbanks. Failure of these nonbanks in particular would have a disproportionate effect on lower-income and minority borrowers.

In the event of the failure of a nonbank, the government (through Ginnie Mae and the GSEs) will probably bear the majority of the increased credit and operational losses that will follow. In the aftermath of the financial crisis, the government shared some mortgage credit losses with the banking system through putbacks and False Claims Act prosecutions. Now, however, the banks have largely retreated from lending to borrowers with lower credit scores and instead lend to nonbanks through warehouse lines of credit, which provide banks with numerous protections in the event of nonbank failure.

Although the monitoring of nonbanks on the part of the GSEs, Ginnie Mae, and the state regulators has increased substantially over the past few years, the prudential regulatory minimums, available data, and staff resources still seem somewhat lacking relative to the risks. Meanwhile, researchers and analysts without access to regulatory data have almost no way to assess the risks. In addition, although various regulators are engaged in micro-prudential supervision of individual nonbanks, less thought is being given, in the housing finance reform discussions and elsewhere, to the question of whether it is wise to concentrate so much risk in a sector with such little capacity to bear it, and a history, at least during the financial crisis, of going out of business. We write this paper with the hope of elevating this question in the national mortgage debate. (52-53)

As with last week’s paper on Mortgage Insurers and The Next Housing Crisis, this paper is a wake-up call to mortgage-market policymakers to pay attention to where the seeds of the next mortgage crisis may be hibernating, awaiting just the right conditions to sprout up.

Can I Refinance?

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photo by GotCredit.com

LendingTree quoted me in Can I Refinance? Refinance Requirements for Your Mortgage. It opens,

While there are many reasons to refinance a mortgage, one of the biggest factors at play is whether or not you’ll be able to get a better interest rate. When interest rates drop, homeowners are incentivized to refinance into a new mortgage with a lower rate and better terms because it can potentially save them a boatload of money over the course of their loan.

Not only can refinancing save money on interest payments, but it can lead to lower monthly payments, or be a way to get rid of a pesky primary mortgage insurance requirement once you’ve earned enough equity in your home. Homeowners can also tinker with their repayment timeline when they refinance, choosing to lengthen their loan term or even shorten it to pay off their home faster.

The first question before you refinance your mortgage is simple: Does it make financial sense? Refinancing a mortgage comes with the same closing costs and fees as a regular mortgage, so you must stand to earn more by refinancing than you’ll pay to do it.

If you’ve had the same mortgage rate since the aughts or earlier, chances are you could have much to gain by refinancing in today’s lower rate environment.

The average interest rate on a 30-year, fixed-rate mortgage hit a low point of 3.31% on Nov. 21, 2012 and hasn’t budged all too much since then. Rates currently stand at 4.32% as of Feb. 8, 2018. By comparison, rates were routinely in the double digits in the 80s and early 90s.

Will rates continue on the upward trend? Unfortunately, nobody knows. But rate behavior will very likely play a key role in your decision.

Once you’ve decided refinancing makes financial sense, the next question should be this: What does it take to qualify? That’s what we’ll cover in this guide.

If you hope to refinance before rates climb any further, it’s smart to get your ducks in a row and find out the refinance requirements for your mortgage right away. Keep reading to learn the minimum requirements to refinance your mortgage, how your credit score may come into play and what steps to take next.

Can you refinance your home?

Lenders consider three main criteria when approving consumers for a home refinance – income, equity, and credit.

  • Debt and income.
  • Equity. Equity is important because lenders want to confirm possibly getting their money back out of your home if you default on your mortgage.
  • Credit. Any lending situation will involve a credit check. “They look at your credit score to see if you have the willingness to pay your mortgage back – to see if you’re creditworthy,” said David Reiss, Professor of Real Estate Law at The Center for Urban Business Entrepreneurship at Brooklyn Law School. “Do you have a low credit score or a high credit score? Do you pay your bills on time?” he asked. “These are all things your lender needs to know.”

While the above factors play a role in whether you’ll qualify to refinance your home, lenders do get fairly specific when it comes to how they gauge your income to determine affordability. Since the amount of income you need to qualify for a new mortgage depends on the amount you wish to borrow, lenders typically use something called “debt-to-income ratio” to measure your ability to repay, says Reiss.

Your debt-to-income ratio (DTI)

During the underwriting process for a conventional loan, lenders will look at all the factors that make them comfortable extending you a loan. This includes your income and your debt levels, says Reiss. “Debt-to-income ratio is an easy way for lenders to determine if you have too many debt payments that might interfere with your home mortgage payment in the future.”

To come up with a debt-to-income ratio, lenders look at your debts and compare them with your income.

But, how is your debt-to-income ratio determined? Your debt-to-income ratio is all of your monthly debt payments divided by your gross monthly income.

In the real world, someone’s debt-to-income ratio would work something like this:

Imagine one of your neighbors has a gross monthly income of $4,000, but they pay out $3,000 per month toward rent payments, car loans, child support, and student loans. Their debt income ratio would be 75% because $3,000 divided by $4,000 is .75.

Reiss says this factor is important because lenders shy away from consumers with debt-to-income ratios that are considered “too high.” Generally speaking, lenders prefer to loan money to borrowers with a debt-to-income ratio of less than 43% but 36% is ideal.

In the example above where your neighbor has a monthly gross income of $4,000, this means he or she may have to get all debt payments down to approximately $1,700 to qualify for a mortgage. ($1,700 divided by $4,000 = .425 or 42.5%).

There are exceptions to the 43% DTI rule, according to the Consumer Financial Protection Bureau. Some lenders may offer you a mortgage if your debt-to-income ratio is higher than 43%. Situations, where such mortgages are offered, include when a borrower has a high credit score, a stellar record of repayment or both. Still, the 43% rule is a good rule of thumb to follow when it comes to traditional mortgages.

Other financial thresholds

If you plan to refinance your home with an FHA mortgage, your housing costs typically need to be less than 29% of your income while your total debts should be no more than 41%.

However, the U.S. Department of Housing and Urban Development, which oversees FHA loans, also notes that potential borrowers with lower credit scores and higher debt-to-income ratios may need to have their loans manually underwritten to ensure “adequate consideration of the borrower’s ability to repay while preserving access to credit for otherwise underserved borrowers.”

Mortgage broker Mark Lewin of Caliber Home Loans in Indiana even says that in his experience, individuals with good credit and “other compensating factors” have secured FHA loans with a total debt-to-income ratio of 55%.

Of course, those who already have an FHA loan may also be able to refinance to a lower rate with no credit check or income verification through a process called FHA Streamline Refinancing. Your debt-to-income ratio won’t even be considered.

A VA loan is another type of home loan that has its own set of debt-to-income requirements. Generally speaking, veterans who meet eligibility requirements for the program need to have a debt-to-income ratio at or below 41% to qualify. However, you may be able to refinance your home with an Interest Rate Reduction Refinance Loan from the VA if you already have a VA loan. These loans don’t have any underwriting or appraisal requirements.

Equity requirements

Equity requirements to refinance your mortgage are typically at the sole discretion of your lender. Where some home mortgage companies may require 20% equity to refinance, others have much lighter requirements.

To find out what your home is worth and how much equity you have, you typically need to pay for a home appraisal, says Reiss. “Appraisals are typically required because you have to be able to prove the value of your home in order to refinance, just like you would with a traditional mortgage.”

There are a few exceptions, however. Mortgage refinancing options that may not require an appraisal include:

  • Interest Rate Reduction Refinance Loans from the VA
  • FHA Streamline Refinance
  • HARP (Home Affordable Refinance Program) Mortgages

Explaining loan-to-value ratio, or LTV

Loan-to-value ratio is a figure determined by assessing how much you owe on your home in relation to its value. If you owe $80,000 on a home worth $100,000, for example, your LTV would be 80% and you would have 20% equity in your home.

This ratio is important because it can determine whether your lender will approve you for a refinance. It can also determine the interest rates you’ll pay and other terms of your loan. If you have less than 20% equity in your home, for example, you may face higher interest rates and fees when you go to refinance.

Having less than 20% equity when you refinance may also cause you to have to pay PMI or private mortgage insurance. This mortgage insurance usually costs between 0.15 to 1.95% of your loan amount each year. If you have less than 20% equity in your home already, you’re already likely to be paying for this coverage all along. However, it’s still worth noting that, if you refinance with less than 20% equity, this coverage will once again get tacked onto your mortgage amount.

Is 80% LTV mandatory?

Your LTV and equity aren’t the end-all, be-all when it comes to your loan refi application. In fact, Reiss says that lenders he has experience with don’t absolutely require borrowers to have 20% equity or a loan-to-value ratio of 80% — so long as they score high on other measures.

“If you meet the lender’s requirements in terms of income and credit, your loan-to-value ratio doesn’t matter as much — especially if you have excellent credit and a solid payment history,” he said. However, lenders do prefer lending to consumers who have at least 20% equity in their homes.

Reiss says he always refers to 20% equity as the “gold standard” because it’s a goal everyone should shoot for. Not only does having 20% equity in your home when you refinance help you avoid paying for the added expense of PMI, but it can help provide more stability in your life, says Reiss: “Divorce, disease, and death in the family can and do happen, but having equity in your home makes it easier to overcome anything life throws your way.”

For example, having more equity in your home makes it easier to refinance into the best rates possible. Having a lot of equity is also ideal when you have to sell your home suddenly because it means you’re more likely to turn a profit and less likely to take a loss. Last but not least, if you have plenty of equity in your home, you can access that cash for emergency expenses via a home equity loan or HELOC.

“Home equity is a big source of wealth for American families,” he said. “The more equity you have, the more resources you have.”

Fortunately, many households are enjoying greater home equity today, as home values have continued to increase since the housing crisis.

Your credit score

The third factor that can impact your ability to refinance your home is your credit score. When a lender decides whether to give you a mortgage or not, they typically offer the best rates to people with very good credit, or with FICO scores of 740 or higher, according to Reiss.

“The lower your credit score, the higher your interest rate may be,” he said. “If your credit score is bad enough, you may not be able to refinance or get a new mortgage at all.”

The FICO scoring model’s main website, myFICO.com, seems to echo Reiss’ comments. As it notes, a “very good” score is any FICO score in the 740-799 range. If you earn a 740+ FICO, you’re above the national average and have a greater likelihood of getting credit approval and being offered lower interest rates.

Don’t stress about getting a perfect 850 FICO score either. In reality, rates stop improving much once you pass 740.

Understanding Private Mortgage Insurance (PMI)

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photo by David Hilowitz

LendingTree quoted me in Guide to Understanding Private Mortgage Insurance (That’s PMI). It opens,

Part I: Basics of private mortgage insurance (PMI)

What is PMI?

If you’ve ever purchased a home without a large down payment, you may have faced the possibility of paying PMI, or private mortgage insurance. This financial product is a type of loan insurance typically bought by consumers when they purchase a house. However, the premiums paid toward PMI aren’t intended to protect the consumer. Rather, they provide protection for the lender, in case you stop making payments on your home loan.

As the Consumer Financial Protection Bureau (CFPB) notes, PMI is typically arranged by your lender during the home loan process and comes into play when you have a conventional loan and put down less than 20 percent of the property’s purchase price. However, private mortgage insurance is not just associated with home purchases; it can also be required when a consumer refinances his or her home and has less than 20 percent equity in it.

Generally speaking, PMI can be paid in three different ways — as a monthly premium, a one-time upfront premium or a mix of monthly premiums with an upfront fee.

There are also ways to avoid paying PMI altogether, which we’ll address later in this guide.

PMI versus MIP: What’s the difference?

While PMI is private mortgage insurance consumers buy to insure their conventional home loans, the similarly named MIP –  that’s mortgage insurance premium — is mortgage insurance you buy when you take out an FHA home loan.

MIP works kind of like PMI, in that it’s required for FHA (Federal Housing Administration) loans with a down payment of less than 20 percent of the purchase price. With MIP, you pay both an upfront assessment at the time of closing and an annual premium that is calculated every year and paid within your monthly mortgage premiums.

Generally speaking, the upfront component of MIP is equal to 1.75 percent of the base loan amount. The annual MIP premiums, on the other hand, are based on the amount of money you owe each year.

The biggest difference between PMI and MIP is this: PMI can be canceled after a homeowner achieves at least 20 percent equity in his/her property, whereas homeowners paying MIP in conjunction with a FHA loan that originated after June 13, 2013, cannot cancel this coverage until their mortgage is paid in full. You can also get out from under MIP by refinancing your FHA loan into a new, conventional loan. However, you’ll need to leave at least 20 percent equity in your home to avoid having to pay private mortgage insurance on the refi.

Which types of home loans require PMI? MIP?

If you’re thinking of buying a home and wondering if you’ll be on the hook for PMI or MIP, it’s important to understand different scenarios in which these extra charges may apply.

Here are the two main loan situations where you’ll absolutely need to pay mortgage insurance:

  • FHA loans with less than 20 percent down – If you’re taking out a FHA loan to purchase a home, you may only be required to come up with a 3.5 percent down payment. You will, however, be required to pay both upfront and annual mortgage insurance premium (MIP).
  • Conventional loans with less than 20 percent down – If you’re taking out a conventional home loan and have less than 20 percent of the home’s purchase price to put down, you’ll need to pay PMI.

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Part V: Frequently asked questions (FAQs)

Before you decide whether to pay PMI – or whether you should try to avoid it – it pays to learn all you can about this insurance product. Consider these frequently asked questions and their answers as you continue your path toward homeownership.

Q. Is PMI tax-deductible?

According to David Reiss, professor of law and academic program director for the Center for Urban Business Entrepreneurship at Brooklyn Law School, PMI may be tax-deductible but it all depends on your situation. “The deduction phases out at higher income levels,” he says.

According to IRS.gov, the deduction for PMI starts phasing out once your adjusted gross income exceeds $100,000 and phases out completely once it exceeds $109,000 (or $54,500 if married filing separately).