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When you decide to purchase a home, there’s a laundry list of considerations you must keep in mind. Just for starters, you have to pick a location you’re comfortable committing to, find the perfect house and determine what you can afford.
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That last calculation can be more difficult than it seems. You might have a good idea how much money you can use for a down payment. But have you considered how the amount you put down affects what you’ll need to pay for private mortgage insurance?
In this article, we will explain private mortgage insurance and why it’s necessary for many homebuyers.
What is private mortgage insurance?
Private mortgage insurance, commonly called PMI, is an insurance policy that protects your mortgage lender from loss, should you stop making payments on your mortgage. PMI is meant to shield your lender’s investment in your home, not yours.
Mortgage insurance should not be confused with homeowners insurance. Your homeowners insurance policy is meant to protect your home and personal belongings from damage or destruction. If, say, a storm knocks a tree down onto your house, you can likely submit a claim to be reimbursed for the expenses you incur to repair or replace your property.
Mortgage insurance works differently. You’re responsible for paying the policy, but you don’t benefit if there’s a claim.
However, you do benefit from mortgage insurance in general. PMI gives lenders confidence to approve mortgages for people with smaller down payments and lower credit scores, opening up access to homeownership to millions more people.
How PMI works
Most people don’t think too much about private mortgage insurance. It’s mandatory for certain types of loans, and lenders usually choose a private mortgage insurer and package it with your mortgage.
There are several PMI companies for them to choose from. Some of the most common insurers include Essent, Genworth, Mortgage Guaranty Insurance Corporation, National Mortgage Insurance and Radian, according to U.S. Mortgage Insurers.
Who must pay PMI?
Not all homebuyers are responsible for carrying a private mortgage insurance policy. Only borrowers with conventional mortgage who contribute less than a 20% down payment are required to pay for PMI.
Government-backed loans like FHA loans, VA loans and USDA loans have their own versions of insurance. Homeowners who put down more than 20% also are not required to pay private mortgage insurance.
How do you pay PMI?
In most cases, private mortgage insurance premiums are paid monthly and included in the monthly fee you send to your lender. PMI is counted as part of the escrow portion of your monthly mortgage payment.
The lender will then submit your PMI payments to the insurer on your behalf when they’re due, just as is the practice for homeowners insurance and property taxes.
However, there are different ways to cover PMI:
- A monthly premium, which is added to your mortgage payment. This is the most common way to pay.
- A one-time, upfront premium, which is paid at closing in a lump sum.
- A split between an upfront and monthly premium.
You pay for PMI until you’ve built at least 20% equity in your home, at which point you can request that your lender cancel your PMI payments. Alternatively, you can wait for your PMI to automatically be removed when you reach 22% equity.
How much does PMI cost?
The cost of PMI is determined by your credit score and your loan-to-value ratio, which is calculated by dividing your mortgage amount by your home’s value. Generally speaking, PMI could cost you anywhere from $30 to $70 per month for every $100,000 you borrow, according to Freddie Mac.
Similar mortgage insurance programs
Private mortgage insurance is unique to conventional loans, which are backed by government-sponsored enterprises Fannie Mae and Freddie Mac.
A mortgage insurance premium, or MIP for short, is specific to mortgages backed by the Federal Housing Administration, which is overseen by the U.S. Department of Housing and Urban Development.
FHA loans require two types of MIP: annual and upfront. The upfront premium costs 1.75% of the loan amount and is paid at closing. The annual premium ranges from 0.45% to 1.05% of the loan amount — depending on the down payment amount and mortgage term — and is paid in 12 monthly installments each year.
MIP serves a purpose that is similar to that of PMI — protecting the lender if the borrower defaults on their mortgage. However, unlike PMI, mortgage insurance premiums are required for the life of an FHA loan in many cases. Below, we highlight the differences between private mortgage insurance and mortgage insurance premiums.
|Cost||$30 to $70 per every $100K borrowed.||1.75% of the loan amount upfront; 0.45% to 1.05% of the loan amount annually.|
|Payment period||Until you reach at least an 80% LTV ratio.||Either the life of the loan or 11 years (if you put down at least 10% at closing).|
|Loan type||Conventional loans.||FHA loans.|
|Cancellation requirements||Pay down your mortgage to an 80% LTV ratio and make a request with your lender.||Make a 10% down payment or refinance into a conventional loan.|
The benefits of PMI
Private mortgage insurance allows many prospective homebuyers the chance to buy a home much sooner than anticipated, because it applies to buyers who have small down payment amounts. Some conventional mortgage products allow a down payment as low as 3% of the loan amount.
PMI also isn’t just a one-size-fits-all type of cost — typically, the better your credit score, the less you pay.
Additionally, as previously mentioned, you have the ability to cancel your private mortgage insurance payments once you’ve accumulated 20% equity in your home.
How to cancel PMI
Although private mortgage insurance is an added cost and necessary for many buyers to reach their homeownership goals, it doesn’t mean you’re tied to those PMI payments forever. It’s also possible to skip the private mortgage insurance requirement altogether. Here are a few common ways to avoid or cancel PMI.
Request PMI cancellation from your lender
If you believe you’ve built up 20% equity in your home — from paying down your mortgage or experiencing a significant increase in your home’s value, or both — you can request that your mortgage lender remove PMI from your loan. You’ll need to meet several criteria for your request to be honored, according to the Consumer Financial Protection Bureau, which include:
- Submitting your request in writing.
- Maintaining a good payment history and being current on your payments.
- Certifying that there are no other liens on your home, such as a second mortgage.
- Paying for an updated appraisal to verify your home’s value.
If an appraisal verifies that you have reached 20% equity, the lender will cancel the PMI policy.
Refinance your mortgage
Consider refinancing your mortgage to drop PMI payments. A refinance could be an alternative to just simply requesting that your lender cancel PMI, as you not only have the chance to cut PMI from your monthly mortgage payments but also possibly lower your principal and interest payments and reduce your interest rate. Just be sure the benefits outweigh the costs of refinancing before you apply.
However, there’s a caveat: You’ll only be able to remove PMI from your refinanced mortgage if you have at least 20% equity at the time of your refinance. — otherwise, PMI will be factored into your new monthly mortgage payment amount.
Wait for automatic PMI termination
Mortgage lenders are required to remove PMI from your mortgage on the date your outstanding mortgage balance is anticipated to reach 78% of your home’s original value, according to the CFPB. You’ll need to be current on your monthly payments in order to qualify.
The bottom line
Having a mortgage requires more than simply repaying the principal and interest on the loan you borrow. There are many other costs involved, including property taxes, homeowners insurance and, in many cases, private mortgage insurance. While PMI doesn’t directly protect you, it does provide you the opportunity to more quickly enter the housing market.
Still, if you don’t desire to take on the added cost that PMI brings, the best way to avoid paying for it is waiting to buy a home until you have at least a 20% down payment at the ready. The downside to this choice is you run the risk of losing out on buying power if mortgage rates increase, as they are predicted to do.