LTV, PMI, FHA & FNMA – Huh?
Financing a new house can be intimidating, even if you’re not a first-time homebuyer. But fear not, Great Midwest Bank’s loan officers are here to walk you through the process, explain commonly used terms and make the process less scary. As you’ve started your journey to purchasing a new home, you’ve probably run into some acronyms like LTV, PMI, FHA and FNMA. With terms like those, it’s easy to think that the mortgage and finance world are speaking a different language.
Like most industries, we love acronyms in the mortgage world. But we understand it can get overwhelming when you don’t work in our industry. You just want to buy a new home, not learn a whole new vocabulary. Hopefully, this guide will help you decipher some of the lingo you may encounter when shopping for a home mortgage loan.
Loan-to-Value (LTV) assesses the lending risk associated with a mortgage before approval. LTV is determined by the loan amount divided into the value of the home. The higher the risk, the higher the LTV ratio. Basically, the financial institution is trying to determine how likely your loan will go into default.
This is also the point at which we start most conversations with borrowers because the amount (or percentage) of a borrower’s down payment will often dictate the mortgage product utilized. When calculating LTV, the most impactful factors are the down payment, sales price, and appraisal value.
To achieve a lower and more favorable LTV ratio, you can increase your down payment or negotiate a lower sales price of the home.
If you’re more of a math formula person, LTV = loan amount / home value. The home value will be the lesser amount between the home’s appraised value or the purchase price. LTV is commonly expressed as a percentage or a ratio.
Borrowers with a low LTV ratio tend to get loans approved at a higher rate and have a better chance at securing a lower interest rate on their mortgage. It can also make it less likely that the lender will require you to purchase private mortgage insurance (PMI).
Private Mortgage Insurance (PMI)
You’ve probably heard PMI referenced a lot when you’ve been reading or discussing home mortgage lending. Private Mortgage Insurance is generally a requirement that exists when the LTV is above 80%. PMI, similar to other types of mortgage insurance, protects the lender if the borrower stops making payments on their loans.
PMI can add 0.5% to 1% to the entire loan amount. PMI is usually paid monthly, and payments continue until the LTV ratio is below 80%.
Avoiding PMI is typically preferred, as it does add costs to your loan, but for many borrowers – especially first-time homebuyers – PMI is essential in allowing them to buy a new home. It allows them to purchase a home while offsetting risk for the lender.
Great Midwest utilizes a couple of sources for fixed-rate conventional loans, including Fannie Mae (FNMA). When PMI is necessary, we employ a third party – one of a handful of national mortgage insurers – that insures us from loss should a borrower default.
Premiums paid on the loan (either upfront as a single premium OR, more commonly, monthly – but not both) are sent by the lender directly to the private insurer until the LTV typically reaches 80%, at which time the borrower can request release. Lenders typically release it at 78% LTV.
Federal Housing Authority (FHA) Loans
In actuality, Private Mortgage Insurance only exists for non-FHA (Federal Housing Administration) type loans, most often referred to as conventional loans. The nuance here is that, though mortgage insurance exists for FHA, it’s not private. FHA loans are insured by the government.
Federal Housing Administration loans, known as FHA loans, are loans meant for low-to-moderate income borrowers. Because FHA loans have lower down payment and credit requirements, they tend to be popular with first-time homebuyers.
In addition to monthly insurance premiums, FHA loan borrowers also pay an up-front mortgage insurance premium at the time of closing. And unlike with PMI, the monthly insurance premiums that come with an FHA loan do not end after a certain amount of the debt is paid off. Instead, FHA loan recipients can expect to pay those monthly premiums for 11 years or until the loan is paid off, whichever occurs first.
PMI on conventional loans is often less expensive than FHA loans, especially for borrowers with excellent credit and a solid financial footing.
One Last Note on Mortgage Insurance
Last, mortgage insurance in any form may be tax deductible. Consult your tax advisor for more information, as you don’t want to get in trouble with the IRS. Sorry, couldn’t resist one more acronym!
It’s Confusing. That’s Why We’re Here to Help.
Look, we know this may all still be confusing and somewhat overwhelming. We hope we were able to help shed some light, not only on some of the vocabulary you may hear during the homebuying process but also on the process itself. If not, don’t worry. You aren’t alone.
Our loan officers have been helping homebuyers purchase, sell, and refinance their homes, as well as finance home renovation and construction projects for many years. They are well versed in both the vocabulary and the process. Nothing makes us happier than helping people in our communities achieve their dreams of homeownership, so no matter what questions you have, please don’t hesitate to call.