What is the PMI? | Buyer’s Guide to Private Mortgage Insurance


What is the PMI?

Private Mortgage Insurance (PMI) is a type of insurance that is required when you buy a home with less than 20% down payment. PMI is paid by the owner but protects the lender in the event of a foreclosure.

Why would someone pay PMI when it only protects their lender? Because PMI allows you to buy a home with as little as 3% down. To avoid PMI, you usually need at least 20% down payment, which can take years to save.

It is important to remember that the PMI is not eternal. Many people buy a home with a small down payment, pay the PMI upfront, and are able to remove it after a few years. Because PMI helps you buy a home and start building capital sooner, it often pays for itself in the long run.

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What is private mortgage insurance used for?

Private mortgage insurance protects your lender against financial loss if you don’t pay your mortgage and they have to foreclose. The general rule is that if you put 20% down, your lender won’t lose a lot of money in a foreclosure. This is why loans with less more than 20% down requires a PMI as additional security.

Once you have accumulated 20% of the equity in your home, you will have the same financial “cushion” as if you had put down a 20% down payment. At this point, PMI can be removed and you no longer have to pay the monthly fee.

How much does the PMI cost?

PMI rates vary by credit score and down payment amount, but often cost between 0.5% and 1.5% of the mortgage balance each year. Borrowers with a 620 credit score and a 3% down payment (the minimum requirements for a conforming loan) will pay the highest PMI rates, while borrowers with higher FICO scores and/or more money will see reduced rates. A high debt-to-equity ratio can also drive up your mortgage insurance rate.

The annual cost of PMI is divided into monthly installments and added to your regular mortgage payments. For example, let’s say you have a mortgage of $300,000. A PMI rate of 0.5% means you would pay $1,500 per year or $125 per month. A 1.5% rate on the same loan amount would cost $4,500 per year or $375 per month.

Keep in mind that PMI costs will decrease each year as you pay off your mortgage balance, as the PMI rate will be charged on a lower loan amount. Eventually, once the loan is paid off at 80% of your home’s value, the PMI can be completely removed.

When is the PMI required?

Almost all types of home loans require mortgage insurance if you put less than 20% down. Only conventional loans with 20% down payment or more are automatically exempt from PMI.

Conventional loans are mortgage loans not guaranteed by the federal government. The majority of US mortgages are conventional “conforming” loans, which means they conform to the lending guidelines set by Fannie Mae and Freddie Mac. Conventional loans with less than 20% down almost always require PMI, with the exception of a few niche programs which generally have higher interest rates.

Government guaranteed loans are not immune, however. Instead of PMI, they charge their own insurance fee. With an FHA, VA, or USDA loan, you will pay some sort of insurance fee regardless of how much your down payment is.

  • FHA Loans charge mortgage insurance premiums (MIP). There are both upfront and monthly fees
  • USDA Loans charge for mortgage insurance (IM). There are both upfront and monthly fees
  • AV loans only charge an upfront warranty fee, called a VA financing fee. There is no monthly PMI

The main difference between conventional PMI and FHA mortgage insurance is that FHA mortgage insurance generally lasts for the life of the loan. The same goes for USDA mortgage insurance. By comparison, the conventional PMI can be removed once you have enough equity in the house.

VA loans are the only traditional home loan that does not charge monthly mortgage insurance with less than 20% down payment. There are only one-time fees (the “VA financing fees”) that most people build into their loan amount. Only veterans, military personnel, and a few closely related groups are eligible for VA loans.

Is the PMI bad?

PMI does not protect the borrower, yet he is the one who has to pay. For this reason, PMI often gets bad press, and many homebuyers want to avoid it if they can.

But there is also a major advantage to the PMI. If you’re willing to pay the PMI, you might be able to buy a house with just 3-5% down payment. It can get you a home years sooner than if you waited to save 20% down payment. And, when home values ​​are rising rapidly, homeowners typically earn far more in equity than they have spent on PMI. So, in a sense, the extra costs can be amortized (and even more).

Remember that when you have 20% equity in your home, which means your loan amount is less than 80% of your home’s value, you can stop paying PMI. These monthly fees will be permanently waived. So you can think of PMI as a temporary cost that brings long-term benefits.

For more information, read: How much does mortgage loan insurance cost? PMI cost vs benefit.

When can I stop paying PMI?

You can stop paying for private mortgage insurance when your mortgage balance drops to 80% of the current appraised value of your home. When house prices rise rapidly, it can happen quite soon — maybe even a year or two — after you buy your property.

If you want to stop PMI payments when you reach this 80% loan-to-value threshold, you will need to ask your lender to remove it. A new appraisal may be necessary if your appraisal is based on rapidly rising real estate values. Otherwise, the PMI will automatically be canceled when your mortgage balance is paid off at 78% of the value of your home.

To be clear, this only applies to conventional loans. If you have a government-backed loan from the FHA or USDA, the mortgage insurance is usually permanent. To remove it, you will need to refinance your government loan and a conventional loan once you have at least 20% equity. At this point, you may qualify for a conforming loan without PMI.

Can I avoid the PMI?

You might be able to avoid private mortgage insurance with less than 20% down payment. But, unless you qualify for a VA loan, it won’t be easy.

For example, you can get lender paid mortgage insurance (LPMI) from some lenders. This may sound great, but there is a catch. Mortgage lenders charge higher interest rates on loans without PMI. And this higher rate accompanies you for the duration of the loan, unlike the PMI, which can be eliminated after a few years.

Supplemental loans are another alternative to mortgage insurance. With a piggyback mortgage, you put down a 10% down payment, use a standard mortgage for 80% of the home price, and cover the remaining 10% with a second mortgage (usually a HELOC). A piggyback loan could save you money in the long run, but it’s harder to qualify and the arrangement is more complex. So ask a lender to walk you through your options if you’re considering this.

Note that some programs for first-time buyers offer special, low PMI rates. Check out Fannie Mae’s HomeReady and Freddie Mac’s Home Possible. Some individual lenders also offer their own proprietary programs without PMI. But these usually cater to well-defined groups, such as first-time buyers with below-average incomes, doctors, teachers, first responders, and more.

Your next steps

PMI may look unappealing, but it’s actually a very useful tool for homebuyers. Using a low down payment loan with PMI can land you in a home much sooner than you thought possible. And remember that the PMI is not forever; you may be able to delete it.

So before delisting PMI, explore your options. Ask a lender to explain the long-term costs and benefits of using PMI. You may find this to be a wise decision in the end.

The information contained on The Mortgage Reports website is provided for informational purposes only and does not constitute advertising for products offered by Full Beaker. The views and opinions expressed herein are those of the author and do not reflect the policy or position of Full Beaker, its officers, parent company or affiliates.


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