Jeffrey Wade
Private mortgage insurance (PMI) is a type of insurance that you may be required to purchase if you take out a conventional loan with a down payment of less than 20% of the purchase price. PMI is designed to protect the lender in the event that the borrower defaults on their loan payments. The cost of PMI is typically added to the borrower's monthly mortgage payments and can increase the overall cost of the loan. PMI can be cancelled once the borrower has reached a certain level of equity in their home or has paid down a significant portion of the loan balance. While PMI can make it easier to qualify for a loan, it is important to consider the additional cost and the fact that it only protects the lender, not the borrower.
| Characteristics | Values |
|---|---|
| Type | Private mortgage insurance (PMI) is an additional fee for conventional mortgage borrowers. |
| Purpose | PMI protects the lender, not the borrower, in case the borrower stops making payments on their loan. |
| Requirement | PMI is required if the borrower takes out a conventional loan with a down payment of less than 20% of the purchase price. |
| Cost | The cost of PMI depends on the loan amount, down payment size, type of mortgage, and credit score. It typically ranges from 0.46% to 1.86% of the loan amount annually. |
| Payment Options | PMI can be paid monthly as part of the mortgage payment or as a one-time upfront premium. Lenders may also offer a combination of upfront and monthly payments. |
| Cancellation | PMI can be cancelled when the borrower reaches 20% equity in their home or when the mortgage balance reaches 78%- 80% of the home's value. |
| Alternatives | Other loan options that may not require PMI include FHA loans, USDA loans, and VA loans. |
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What You'll Learn
Who does private mortgage insurance protect?
Private mortgage insurance (PMI) is a type of mortgage insurance that protects the lender—not the borrower—if the borrower stops making payments on their loan. It is an additional cost that is rolled into the borrower's monthly mortgage payment. The requirement to buy PMI is usually applicable when a borrower takes out a conventional loan with a down payment of less than 20% of the purchase price.
PMI is arranged by the lender and provided by private insurance companies. It insures the lender against loss caused by borrowers failing to make loan payments. If a borrower falls behind on their mortgage payments, PMI does not protect them and they can still lose their home through foreclosure.
PMI can help borrowers qualify for a loan that they might not otherwise be able to get. However, it increases the cost of the loan. Borrowers with excellent credit get the lowest PMI rates. The average annual cost of PMI typically ranges from $30 to $70 per $100,000 borrowed.
Borrowers can request to cancel PMI once certain conditions are met, such as when the mortgage principal balance is less than 80% of the original appraised value. An appraisal will likely be required to cancel PMI. Lenders are required to notify borrowers annually that it is possible to cancel PMI.
In summary, PMI protects only the lender in the event of borrower default and foreclosure. While PMI can help borrowers qualify for loans, it increases the cost of borrowing and does not provide any financial protection for the borrower.
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How much does it cost?
Private mortgage insurance (PMI) is a type of insurance that you are required to pay if you take out a conventional mortgage with a down payment of less than 20%. It protects the lender in the event that you default on your loan. The cost of PMI varies depending on factors such as the down payment amount and the homebuyer's credit score.
The average cost of PMI is around 0.4% to 1.5% of the original loan amount per year. For example, if you have a $400,000 mortgage, your PMI costs may range from $1,600 to $6,000 per year, or $133 to $500 per month. The higher the risk for the mortgage insurer, the higher your premium will be. Borrowers with lower credit scores, high debt-to-income ratios (DTIs), and smaller down payments will typically pay higher PMI rates.
You can use a PMI calculator to estimate your monthly mortgage payment with PMI. This will take into account factors such as the home price, down payment, interest rate, and credit score to provide an accurate estimate of your PMI costs.
While PMI can increase the overall cost of your mortgage, it is worth considering the benefits of owning a home sooner rather than continuing to rent. PMI is also a temporary expense, as it can be canceled once you have paid off a certain percentage of your mortgage or reached a certain point in your loan term. By building your credit score, paying down debt, and saving for a larger down payment, you may be able to reduce your PMI costs.
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When can it be cancelled?
Private mortgage insurance (PMI) can be removed or cancelled under several conditions. Firstly, you can request to cancel PMI when your mortgage balance reaches 80% of your home's original value. The original value is either the contract sales price or the appraised value of your home when you purchased it, whichever is lower. If you have refinanced, the original value is the appraised value at the time of refinancing. You may need to provide evidence, such as an appraisal, that the value of your property has not declined below the original value.
Secondly, federal law and the Homeowners Protection Act of 1998 (HPA) require lenders to automatically cancel PMI when the loan-to-value (LTV) ratio reaches 78% of the home's purchase price or when the loan term reaches its midpoint, whichever comes first. This typically occurs halfway through the original term of the loan, such as after 15 years for a 30-year loan.
Thirdly, you can remove PMI by refinancing your loan, getting a reappraisal, or paying down your mortgage faster. Additionally, some lenders may allow PMI removal under their own standards, and you may be able to avoid PMI altogether by making a 20% down payment or choosing a different type of loan, such as an FHA, USDA, or VA loan.
It's important to note that the requirements for removing PMI may vary depending on the type of property and the loan owner. For multi-unit properties, investment properties, or loans owned by Freddie Mac, the rules for cancelling PMI may differ.
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What are the alternatives?
Private mortgage insurance (PMI) is a type of insurance that you may be required to purchase if you take out a conventional loan with a down payment of less than 20% of the purchase price or refinancing a conventional loan with less than 20% equity. It protects the lender, not the borrower, in the event of default on the loan.
If you are looking to avoid paying for PMI, there are a few alternatives you can consider:
- Larger down payment: One way to avoid PMI is to make a down payment of 20% or more on your home purchase. This reduces the risk for the lender, eliminating the need for PMI.
- Higher interest rate: Some lenders offer conventional loans with smaller down payments that do not require PMI. However, as a trade-off, these loans usually carry a higher interest rate. It is important to consider the overall cost implications, as paying a higher interest rate may be more or less expensive than paying for PMI, depending on various factors such as the length of your loan term.
- Government-backed loans: Government-backed loan programs, such as FHA loans (insured by the Federal Housing Administration), USDA loans (for rural areas), and VA loans (for military members), do not require PMI. However, these loan programs may have their own associated fees and requirements, so be sure to research them thoroughly.
- 80-10-10 Loan or Piggyback Loan: With this type of loan, you make a 10% down payment and take out two mortgages for the remaining 90% of the purchase price. This structure eliminates the need for PMI, but it's important to carefully evaluate the costs and risks associated with having two mortgages.
- Lender-paid mortgage insurance (LPMI): In some cases, lenders may offer the option of LPMI, where they pay the mortgage insurance premium but pass on the cost to you in the form of a higher interest rate. This option can eliminate the upfront cost of PMI but may result in higher overall costs over time.
- Saving for a larger down payment: If you are not in a rush to buy a home, consider saving up to make a 20% down payment. This option may take time, but it can help you avoid the additional cost of PMI and potentially secure a more favourable loan structure.
When considering alternatives to PMI, it is important to carefully evaluate your financial situation, loan options, and the potential short-term and long-term costs associated with each choice. Consulting with a financial advisor or mortgage specialist can help you make an informed decision that aligns with your specific circumstances and goals.
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How is it paid?
Private mortgage insurance (PMI) is an extra fee for conventional mortgage borrowers who make a down payment of less than 20%. It is arranged by the lender and provided by private insurance companies. The insurance protects the lender, not the borrower, in case the borrower defaults on their loan.
There are several ways to pay for PMI. The most common method is to pay a monthly premium that is added to your mortgage payment. The monthly premium is shown on your Loan Estimate and Closing Disclosure. The cost of PMI depends on several factors, including the size of the mortgage loan, your credit score, and the type of mortgage. Borrowers with excellent credit get the lowest PMI rates.
Another option is to pay the PMI cost in one upfront premium, which is paid at closing. This option can result in lower monthly mortgage payments, but it may not be feasible if you do not have the funds available upfront. It is important to note that if you make an upfront payment and then move or refinance, you may not be entitled to a refund of the premium.
A third option is a combination of upfront and monthly payments, known as a split-premium PMI arrangement. With this option, you pay a larger upfront fee that covers part of the overall insurance costs, and the remainder is added to your monthly mortgage payment. This strategy can be helpful if you have a higher debt-to-income ratio, as it can lower your estimated mortgage payment and help you avoid taking on too much debt.
Additionally, there is the option of lender-paid PMI, where the lender pays the premiums, but you pay a higher interest rate on the loan. This option may end up costing more over time, and it cannot be canceled in the same way as borrower-paid PMI.
It is worth noting that PMI is not required if you make a 20% down payment, and there are other types of loans, such as FHA loans, that may be more suitable for borrowers with lower down payments.
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Frequently asked questions
Private mortgage insurance (PMI) is an extra expense for borrowers who take out a conventional loan with a down payment of less than 20%.
Private mortgage insurance protects the lender, not the borrower. It insures the lender against loss caused by borrowers failing to make loan payments.
The cost of PMI depends on several factors, including the size of the mortgage loan, the type and term of the loan, and the borrower's credit score. The average annual cost typically ranges from $30 to $70 per $100,000 borrowed.
PMI is usually paid as part of your monthly mortgage payment, but some lenders may offer the option to pay the PMI cost upfront or with a combination of upfront and monthly payments.
Yes, PMI can generally be cancelled once you have reached 20% equity in your home or paid off a significant portion of your loan. Lenders are required to cancel PMI when the mortgage balance reaches 78% of the original value of the home.
