What is a title examination?

Using Title Insurance to Protect Your Interest in Your Home

Title is the right to own, possess, use, control, and dispose of property. When you buy a home, you are actually buying the seller’s title to the home. Before the closing, an attorney or title company (normally hired by your mortgage lender) will usually conduct a title examination by searching public records. The purpose of a title examination is to discover any problems that might prevent you from getting clear title to the home. The title examiner will then issue a report that describes the property, along with any title defects, liens, or encumbrances discovered in the course of the title examination.

What are some common title problems?

Most run-of-the-mill title problems can be cleared up before the closing. But in some cases, certain title problems can delay the closing. If a title problem is severe enough, you may decide not to purchase the home. A title problem can even result in your mortgage lender refusing to finance the purchase. Many different situations can affect a property’s title. For example:

  • A home’s seller claims to be single, but a title search reveals that the seller is married and owns the house with his or her spouse.
  • A title search reveals that the property is titled in a deceased individual’s name, but there is no will on file to indicate how he or she disposed of it.
  • A home’s sellers took out a home improvement loan, which they have since repaid. However, the lien was never removed from the title.
  • A home’s sellers had a dispute with a contractor over the workmanship on some home renovations, and the sellers withheld final payment on the contract. The contractor filed a mechanic’s lien on the property, which was never removed.
  • You are buying a home and a property survey discovers that the family room that the sellers added on a few years ago is partially situated on a neighbor’s property.

What is title insurance?

Title insurance protects you against title defects that were not discovered in the course of the initial title examination and that may not appear until after you’ve taken ownership of the property. A title insurance policy protects you and your heirs against title defects for as long as you own the property. The policy represents the title insurance company’s responsibility to compensate you for any covered loss caused by a defect in the title or any lien or encumbrance that was not discovered in the title examination.

Title insurance companies usually offer two types of title insurance policies: standard and extended. Standard policies provide limited coverage, offering protection for certain off-record title problems (e.g., fraud), as well as those that could be uncovered during a search of public records (e.g., recorded mechanic’s liens). Extended policies provide the same coverage as standard policies, as well as additional coverage for title problems that aren’t found so easily, such as unrecorded liens and title defects that could only be uncovered during an inspection of the property.

You usually pay a one-time fee for title insurance, the price of which varies depending on the location of the home, its purchase price, and the type of title insurance coverage you select.

Most title insurance policies contain coverage exceptions, so it is important to understand exactly what is covered by the policy.

What about lender’s title insurance?

When you get a mortgage, most mortgage lenders require you to take out lender’s title insurance, which protects the lender’s interest in the property. Coverage on a lender’s policy is limited to the amount of the loan and gradually decreases as the loan is paid off. Keep in mind that a lender’s title insurance policy does not protect your full interest in the property. As a result, you should consider purchasing a separate owner’s policy to protect your interest in case of title defects.

Private Mortgage Insurance (PMI)

What is private mortgage insurance (PMI) and why do you need it?

If you are applying for a conventional mortgage and have a down payment of less than 20%, your lender may require you to have private mortgage insurance (PMI). Low down payment mortgages are somewhat risky for lenders, because they believe you are more likely to default on a loan in which you have very little invested. For this reason, lenders generally require PMI if you are borrowing more than 80% of the value of the home you are purchasing (i.e., your down payment is less than 20%).

Amounts paid for qualified mortgage insurance in 2015 may be tax deductible. You can generally treat amounts you paid during 2015 for qualified mortgage insurance as home mortgage interest, provided that the insurance was associated with home acquisition debt, and was being paid on an insurance contract issued after 2006. Qualified mortgage insurance is mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, the Rural Housing Service, and qualified private mortgage insurance (PMI) providers. The deduction is phased out, though, if your adjusted gross income was more than $100,000 ($50,000 if married filing separately) and no deduction is allowed if your AGI exceeds $109,000 ($54,000 if married filing separately).

How much does PMI cost?

PMI premiums vary depending on the insurance company, but they are usually based on factors such as the type of mortgage loan and the loan amount. PMI premiums are often paid to your loan servicer along with your monthly housing payment (principal, interest, taxes, and insurance). Although PMI can be expensive, you may be unable to qualify for a mortgage without it.

Can PMI ever be removed?

If you are concerned about taking on PMI payments, keep in mind that you may not have to pay PMI forever. For loans originated after July 29, 1999, your lender is obligated to cancel your PMI when the principal balance on your loan is scheduled to reach 78% of the original value of your home or once you have reached the midpoint of your loan’s amortization schedule, provided you have a good payment history. Or, you can petition your lender to remove the PMI if you have a good payment history and reach 20% equity in your home.

The FHA has special rules regarding the cancellation of mortgage insurance premiums for loans with a loan-to-value ratio greater than 90%. For more information on FHA loans visit the U.S. Department of Housing and Urban Development website at portal.hud.gov.

Are there any alternatives to paying PMI?

If you don’t have at least 20 percent for a down payment, there are a couple of alternatives to paying PMI. Consider asking if your lender is willing to increase your mortgage interest rate rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly insurance premium. However, mortgage interest is generally tax deductible, whereas PMI payments are not. Moreover, if you’re able to make prepayments against your mortgage principal, you’ll save on the total interest charge you’ll pay over the term of your mortgage.

With this arrangement, you’ll pay the interest for the life of the loan. In contrast, you can generally remove PMI once you obtain a certain amount of equity in your home.

Another alternative to paying PMI is 80-10-10 financing (also known as piggyback financing). With this type of financing, a lender provides a traditional 80 percent first mortgage. You then obtain a 10 percent second mortgage and make a 10 percent down payment. Keep in mind that 80-10-10 financing can be altered to accommodate the size of your down payment (e.g., you could put 8 percent down and obtain 80-12-8 financing). However, the lower your down payment, the higher the loan fees and interest rate may be.

Although the mortgage interest you pay is generally tax deductible, the initial and ongoing costs of these arrangements may be higher than your PMI payments would be, particularly if you put less than 10 percent down

Choosing a Mortgage

Choosing a mortgage that’s right for you

Like homes, mortgages come in many sizes and types. The type of mortgage that’s right for you depends on many factors, such as your tolerance for risk and how long you expect to stay in your home.

Conventional fixed rate mortgages

As the name implies, the interest rate on a fixed rate mortgage remains the same throughout the life of the loan. Your monthly payment (consisting of principal and interest) generally remains the same as well. The entire mortgage is repaid in equal monthly installments over the term (length) of the loan. For this reason, fixed rate mortgages often appeal to individuals with a low tolerance for the risk associated with fluctuating monthly payments. The usual terms for fixed rate mortgages are 15 and 30 years.

Adjustable rate mortgages (ARMs)

With an ARM, also called a variable rate mortgage, your interest rate is adjusted periodically, rising or falling to keep pace with changes in market interest rate fluctuations. Since the term of your mortgage remains constant, the amount necessary to pay off your loan by the end of the term changes as your loan’s interest rate changes. Thus, your monthly payment amount is recalculated with each rate adjustment.

Depending on what’s specified in the mortgage contract, an ARM can be adjusted semi-annually, quarterly, or even monthly, but most are adjusted annually. The adjustments are made on the basis of a formula specified in the mortgage contract. To adjust the rate, the lender uses an index that reflects general interest rate trends, such as the one-year Treasury securities index, and adds to it a margin reflecting the lender’s profit (or markup) on the money loaned to you. Thus, if the index is 5.75 percent and the markup is 2.25 percent, the ARM interest rate would be 8 percent.

What’s to keep the interest rate from going through the roof–or, for that matter, from plunging through the floor? Most ARMs specify interest rate caps. The periodic adjustment cap may limit the amount of rate change, up or down, allowed at any single adjustment period. A lifetime cap may indicate that the interest rate may not go any higher–or lower–than a specified percentage over–or under–the initial interest rate.

The initial interest rates (referred to as teaser rates) on ARMs are generally lower than the rates on fixed rate mortgages. An ARM may be a good option for an individual who can tolerate uncertainty in his or her mortgage interest rate and fluctuations in his or her monthly mortgage payment amount or plans to live in his or her home for only a short period of time.

Hybrid ARMs

Hybrid ARMs are mortgage loans that offer a fixed interest rate for a certain time period (3, 5, 7, or 10 years), and then convert to a 1-year ARM.

The initial fixed interest rate on a hybrid ARM is often considerably lower than the rate on either a 15-year or 30-year fixed rate mortgage. The longer the initial fixed-rate term, however, the higher the interest rate for that term will be. Generally speaking, even the lowest of these fixed rates is higher than the initial (teaser) rate of a conventional 1-year ARM.

Hybrid ARMs are ideal for individuals who plan to stay in their homes for a short period of time (3 to 10 years), since they can take advantage of the low initial fixed interest rate without worrying about how the loan will change when it converts to an ARM. If you think your plans may change or you are planning on staying put for a while, look for a hybrid ARM with a conversion option. This option will allow you to convert your loan to a fixed rate loan before it turns into an ARM.

Government mortgage programs

Generally, government mortgage programs offer mortgages insured and/or guaranteed by agencies of the federal government. Some of the advantages of these types of mortgages include:

  • Fixed interest rates that are lower than those offered by conventional loans
  • Little or no down payment required
  • Less stringent qualifying guidelines than conventional loans

FHA loans

Federal Housing Administration (FHA) mortgages are similar to conventional fixed rate mortgages, except that they are insured by the federal government. A Federal Housing Administration (FHA) mortgage may allow a down payment of as little as 3.5 percent. Keep in mind, however, that FHA loans require borrowers with down payments of less than 20% to pay mortgage insurance premiums.

FHA mortgage amounts are limited, and the maximum loan amount varies among geographic regions.

VA loans

The Department of Veterans Affairs (VA) mortgages are similar to conventional fixed rate mortgages. VA mortgages are available to qualified veterans and their surviving spouses.

VA loan limits vary, depending on location. Generally, a lender will offer a VA loan equal to four times a veteran’s available entitlement (provided certain underwriting requirements are met). Currently, the basic entitlement for veterans is $36,000. You can visit http://benefits.va.gov/homeloans for more information.

Jumbo loans

A jumbo loan (also known as a nonconforming loan) is any mortgage over $417,000, or over $625,5000 in the most expensive parts of the country, for a single-family home or condominium. This figure is set by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), and is adjusted annually. Jumbo loans are called nonconforming loans because these organizations will not underwrite them, making them more risky to lenders. As a result, lenders often set their jumbo loan interest rates higher than conventional mortgage rates.

If you’re just over the underwriting limit for conforming loans and are having to consider a jumbo loan, you might want to either look for a less expensive house or consider increasing your down payment in order to qualify for a conforming loan with a lower interest rate. Over the life of your mortgage, a lower interest rate could create significant savings.