What is PMI on Your Mortgage?

If you're considering applying for a mortgage, understanding how private mortgage insurance (PMI) works is critical, especially if you cannot pay 20% upfront. This comprehensive guide explains what PMI is when required, how much it costs, and tips for removing it from your loan.

Key Takeaways

PMI protects lenders when borrowers put down less than 20% on a mortgage.
Monthly premiums typically add 0.5%–1% of the loan amount to payments.
Conventional loans need PMI for down payments under 20%.
FHA loans require a down payment amount.
PMI can be removed by reaching 20% equity and requesting cancellation.
Avoiding PMI may be possible through alternative options or a 20% down payment.

What Exactly is Private Mortgage Insurance (PMI)?

Private mortgage insurance (PMI) is an additional insurance policy that lenders require when borrowers make a down payment of less than 20% on a home loan.

PMI protects lenders in case the borrower fails to repay the mortgage. It is typically charged as a monthly premium added to the regular mortgage payment.

Conventional loans almost always require PMI for down payments under 20%. Government-backed FHA loans need it for any size down payment.

Why Do Lenders Require PMI?

Lenders require PMI when borrowers put down less than 20% because it provides them financial protection if the borrower defaults on payments or foreclosure is needed.

The insurance policy reimburses the lender for any losses up to the amount of PMI coverage. This guarantees that the lender will recover funds even if the borrower stops making payments.

PMI allows lenders to approve loans for buyers who don't have 20% down while reducing their risk, making financing more accessible.

How Much Does PMI Typically Cost?

Monthly private mortgage insurance premiums usually range from 0.5% to 1% of the total yearly loan amount. A $200,000 loan equals $1,000–$2,000 annually, or around $83–$167 monthly.

Exact PMI rates depend on your down payment size, loan amount, credit score, and lender. FHA mortgage insurance costs are different, involving an upfront fee plus annual premiums.

When Is PMI Required?

For conventional loans, private mortgage insurance is typically required whenever borrowers put down less than 20% of the home's value as a down payment.

So, even a 15% or 10% down payment on a conventional loan will trigger the need for PMI since less than 20% equity is invested upfront.

FHA loans backed by the Federal Housing Administration require mortgage insurance, no matter the borrower's down payment amount. Even 20% down still necessitates FHA mortgage insurance.

How Can I Avoid Paying PMI?

The easiest way to avoid PMI is to make a down payment of 20% or more on a conventional loan. Other options include:

Piggyback on a second mortgage for the difference.
Paying for lender-paid PMI in exchange for a slightly higher rate
Using government-backed VA, USDA, or FHA loans
Taking out a primary mortgage under 80% and a HELOC for the remainder

While it is possible to avoid it, PMI can provide flexibility to buy sooner, even with a smaller down payment.

How Do I Get Rid of PMI?

Most lenders let borrowers request cancellation of PMI once they build 20% equity in the home through payments and appreciation.

An appraisal confirms the current home value and equity amount before the lender removes PMI. Paying extra toward the principal can help you reach 20% equity faster and stop paying premiums sooner.

What are the Pros and Cons of PMI?

Pros:

Allows buying with less than 20% down.
Provides lender loss protection.
It may be tax deductible.

Cons:

Adds monthly costs to the mortgage payment.
Must be paid until reaching 20% equity.
Can't be removed on FHA loans

PMI gives more financing flexibility but isn't free. Understanding both sides helps borrowers make informed decisions about getting a mortgage with less than 20% down.

Frequently Asked Questions About PMI

Q: How much is PMI?

A: The cost of PMI (Private Mortgage Insurance) varies depending on the loan amount, the loan-to-value ratio, and the borrower's credit score. On average, PMI can range from 0.5% to 1% of the loan amount annually.

Q: How can I avoid PMI?

A: There are several ways to avoid paying PMI. One option is to make a down payment of at least 20% of the home's purchase price. Another option is to take out a piggyback loan, where the borrower takes out a second mortgage to cover part of the down payment.

Q: How can I stop paying PMI?

A: Once you have built up enough equity in your home and reach an 80% loan-to-value (LTV) ratio, you can request to remove PMI. You may need to provide documentation and pay for an appraisal to demonstrate that the value of your home has increased and the loan balance has decreased.

Q: What are the different types of PMI?

A: There are different types of PMI, including borrower-paid mortgage insurance (BPMI) and lender-paid mortgage insurance (LPMI). With BPMI, the borrower pays the premiums for the mortgage insurance. With LPMI, the lender pays the dividends but may charge a slightly higher interest rate.

Q: What is FHA?

A: FHA (Federal Housing Administration) is a government agency that offers mortgage insurance to lenders who originate FHA loans. FHA loans are popular among first-time homebuyers as they require a lower down payment and have more flexible credit requirements.

Q: How much does the PMI cost?

A: PMI cost can vary depending on the loan amount, loan-to-value ratio, and borrower's credit score. PMI costs can range from 0.5% to 1% of the loan amount annually.

Q: How is PMI payment calculated?

A: PMI payment is typically calculated based on a percentage of the loan amount. The exact calculation method may vary between lenders. Still, it is usually determined by multiplying the loan amount by the PMI premium rate and dividing it by 12 to get the monthly PMI payment.

Q: What is an FHA loan?

A: An FHA loan is a mortgage the Federal Housing Administration insures. It is designed to help borrowers with lower credit scores and smaller down payments to qualify for mortgages.

Q: How can I cancel PMI?

A: You can cancel PMI once you have reached at least 20% equity in your home. You must contact your mortgage servicer to cancel PMI and request the cancellation. The lender may require an appraisal to confirm the current value of your home.

Q: What is the cost of PMI automatically?

A: The cost of PMI is automatically added to your monthly mortgage payment. It is typically included as a separate line item along with your principal, interest, and other escrow items such as property taxes and homeowners insurance.

Conclusion

Knowing PMI's costs, cancellation terms, and trade-offs allows borrowers to strategically navigate financing a home purchase with less than a 20% down payment.

SOURCE:
Termination of Conventional Mortgage Insurance
Mortgage Insurance Coverage Requirements