As home prices rise, down payments will continue to increase, too. But not everyone has the money up front to pay the initial cash commitment of a large down payment. For those people, lenders require Private Mortgage Insurance (PMI) as a way to protect themselves against the risk of investing in borrowers with less cash up front.
In this article, we’ll discuss what PMI is, how it works, and the pros and cons of different types of PMI.
- PMI is required for most down payments below 20%
- There are different types of PMI
- You can pay PMI up front as a lump sum, as a monthly premium, or a combination of both
- PMI is not permanent
What is Private Mortgage Insurance?
PMI is a type of insurance that lenders often require you to pay when you put down less than 20% on the down payment of a conventional home loan. It protects your lender if you default on your mortgage and allows them to recoup losses tied up in the equity of the home. PMI is usually paid as a monthly premium tacked on to your mortgage payment.
Not all loan types require PMI. It’s typically required for conforming and FHA loans. VA loans do not require PMI and many lenders don’t require PMI on jumbo loans, but may offer a higher interest rate instead.
How much does PMI cost?
The amount you’ll pay for PMI varies depending on various factors and usually ranges from 0.10% to 1.10% of your loan amount per year.
Factors that influence your rate include:
- Your credit score
- The type of loan or loan program you used
- The amount of your down payment
For example, if you are applying for a $500,000 mortgage, making a 15% down payment of $75,000 and have an excellent credit score, .10% is $425 per year or $35 per month. But this is a low-end estimate. Borrowers with less of a down payment or a lower credit score may end up paying hundreds more every month.
Remember that PMI rates can vary between lenders so it’s important to take rates into account when choosing a lender.
The different types of PMI
- Borrower-paid mortgage insurance (BPMI)
This is the most common type of PMI. You will pay a monthly premium in addition to your mortgage payments until you have gained 22% equity in your home.
- Single-premium mortgage insurance (SPMI)
You can also pay PMI as a lump sum at the beginning of the loan, usually as part of your closing costs. SPMI can also be folded into your monthly mortgage payments so there aren’t two separate fees, but then you’ll be paying interest on PMI as well.
- Lender-paid mortgage insurance (LPMI)
Lenders can also pay mortgage insurance directly but they’ll pass the cost on to borrowers through higher interest rates. This type of PMI cannot be cancelled once your equity reaches 22%. The only way to get rid of PMI in this situation is to refinance your mortgage.
- Split-premium mortgage insurance
This type of PMI is a combination of the first two—you will pay a smaller monthly premium after paying some of the lump sum up front. It’s helpful because it splits the costs up evenly so you pay less up front than you would with SPMI alone and your monthly payments are less than they would be with BPMI alone.
- Federal Home Loan Mortgage Protection (MIP)
You may qualify for a Federal Housing Authority (FHA) loan. These loans are backed by the federal government and are specifically designed for borrowers with smaller down payments who buy in rural areas. You’ll pay with a combined lump sum and monthly payments. For FHA loans, PMI is required for the life of the loan in most cases so it cannot be removed unless you refinance your mortgage and choose a different type of loan.
What factors should I consider before committing to a loan with PMI?
PMI has been a very effective tool for both buyers and lenders in competitive markets. But it’s not a golden ticket, either. Before you commit to a loan with PMI, consider the following factors:
The monthly costs
PMI makes your first cash infusion into the overall price of your home more manageable, but it will make your monthly payments higher than if you were only paying a monthly mortgage.
How long you intend to stay in the home
You can usually request to cancel PMI once you have 20% equity in your home. PMI also cancels automatically once you’ve reached 22% equity in the home. But if you don’t intend to stay long enough to achieve those milestones, accepting a loan that requires PMI may not make sense for you.
How it will affect your taxes
Paying higher interest rates versus paying PMI can change your tax bill depending on your local, state, and federal tax laws. Talk to a tax advisor before you take out a loan with PMI.
Ways to get rid of PMI
Luckily, PMI is temporary in most cases. By law, PMI will automatically terminate when your home’s loan-to-value rate reaches 80% or, measured a different way, when your equity reaches 22%. But a lender can continue to charge PMI past these milestones if you’re not current on your mortgage payments or there is a lien on your property.
You can also request to terminate PMI before the automatic termination date once your equity reaches 20%. To do this, follow these steps:
- Write a formal request letter.
- Make sure you are up to date on all payments.
- Wait until there are no payments more than 30 days late within the previous 12-months. Also, make sure there are no payments more than 60 days late within the previous 24 months.
- Clear any liens on your property.
After at least 2 years, if you believe your home has appreciated in value to where you now have at least 25% equity in the home, you can request to have your home reappraised. As long as your balance is 75% or less of the new value of the home and you have a good payment record, the lender will drop the PMI. This is a great option if you make improvements to the home in the short term.
PMI is how buyers with lower down payments can still break into the housing market and begin to build equity. But it’s meant to protect the landers, not the buyers. It can be a very effective tool for buyers depending on things like credit history, monthly budget, and the type of loan they are taking out.
What is the purpose of private mortgage insurance?
PMI protects lenders from financial risk when they underwrite mortgages to borrowers with lower down payments. Borrowers with less cash are seen as more of a financial risk so lenders require PMI as an insurance policy to rely on if borrowers default.
How can I avoid PMI without a 20% down payment?
In order to avoid PMI without 20% down, you would need to take out a second mortgage—or a piggyback loan—to pay for the remainder of the down payment you weren’t able to cover initially. With two mortgages, you’re likely to pay more per month than if you simply pay PMI.
Do you always have to pay PMI?
No. PMI is only for borrowers who don’t pay 20% down when they initiate their mortgage loan.
What credit score will avoid PMI?
There is no credit score that gets a borrower out of paying PMI if a borrower pays less than 20% down. But the better the credit score, the lower your PMI payments will be.
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