When taking out a mortgage, sometimes you’ll be required to pay for private mortgage insurance, also known as PMI. This payment is usually required as part of your mortgage, especially if you make a down payment for less than 20% of your home’s purchase price.
In this guide, we’ll cover everything you need to know about PMI and discuss its various types. We’ll also go over the reasons why you have to pay for mortgage insurance, whether it has any benefits for you, as well as reasons to avoid being saddled with PMI costs – including tips on how to avoid paying for it.
Private mortgage insurance (PMI) is a type of mortgage insurance that borrowers may be required to buy when applying for a loan. Private mortgage insurance protects the lender from losses if the buyer ends up defaulting on the loan.
Generally, a borrower is required to buy PMI when they make a down payment of less than 20% for their home. This means that the mortgage’s loan-to-value (LTV) ratio is more than 80%. The larger the LTV, the more wary lenders are of the buyer, which is why lenders decide to have the buyer pay for PMI.
The Types of PMI
Borrower-paid private mortgage insurance (BPMI) is one of the most common forms of PMI. BPMI comes as a monthly fee you pay monthly on top of your mortgage payment.
Lender-paid private mortgage insurance (LPMI) may sound like the lender is paying for your PMI, but in reality, you’ll still be paying for the PMI. This type of PMI means that lenders will raise the interest rate of your mortgage payment to pay for it. A benefit of this type of PMI is that you could still pay less than a monthly PMI payment.
With a single premium private mortgage insurance, your insurance premium is paid in full upfront. You’ll be paying for less insurance, but you also need a larger payment upfront on top of your down payment and closing costs.
If you choose a split premium private mortgage insurance, you pay part of the PMI upfront and finish the remaining amount as BPMI with your mortgage payment. This provides flexibility if you have cash on hand, but not enough to pay your PMI in full upfront. The upfront payment could range from 0.50 to 1.25 percent of the loan amount, and the monthly payment is based on the net LTV ratio.
A federal home loan mortgage protection (MIP) only applies if you take out an FHA loan. This type of PMI is necessary for all FHA loans and requires an upfront payment as well as a monthly premium.
What Is PMI Paying For?
When lenders give out a loan, they are always concerned with how and if they’ll get their money back. If a homebuyer pays less than 20% on their down payment, they might be considered less likely to make mortgage payments on schedule. In order to make sure that their investment is protected, lenders require the borrower to pay for a PMI on top of their loan.
Private mortgage insurance (PMI) helps the lender cover their loss if you default on your loan. So if they end up foreclosing on your home, the mortgage insurance company will cover a certain percentage of the insured mortgage. Essentially, mortgage insurance means you’re paying to compensate the lender for taking the high risk of lending their money to you.
How Much Does PMI Cost?
The cost of PMI will differ depending on a variety of factors. These factors include your loan amount, the size of your down payment, and your credit score. Other factors like the loan being for an investment property or a second residence also come into play. Generally, the cost is around 0.25 to 2 percent of your loan annually.
The riskier you look to a lender, the higher your premiums will be. Therefore, having a good credit score and a higher down payment helps. You stand a better chance of paying less mortgage insurance premiums with a better credit score and if you pay more on your down payment.
Another thing to note is that annual mortgage insurance is recalculated each year, so as you pay off your loan, your PMI premiums will go down.
When Can I Stop Paying PMI?
If you’re paying for borrower-paid mortgage insurance, lenders are required to cancel your PMI when you have 22% equity in your home. You can send in a written request for cancellation when you reach 20% of your home’s purchase price in home equity, but it’s not a guaranteed cancellation.
Furthermore, some lenders may also allow you to cancel your PMI early if you prepay on your mortgage and have at least 20% home equity. An important thing to keep in mind is that in order to terminate PMI, your mortgage payments must be current.
In addition, your lender is obligated to tell you how long it’ll take for you to qualify for private mortgage insurance cancellation. Information on how to cancel your PMI must also be given each year. In the case of lender-paid mortgage insurance, you’ll be paying for the mortgage insurance premium with the built-in higher interest rate. Essentially, if you choose an LPMI you’ll be paying for PMI until you pay off the loan.
If you opt for a split premium PMI, you’ll pay part of your premiums upfront and you’ll pay the rest monthly like a BPMI. On an MIP, the buyer needs to pay the premium throughout the life of the loan. An exception is given to buyers who pay more than 10% on their down payment, where they can stop paying MIP after 11 years.
Does PMI Benefit Me?
While it seems like private mortgage insurance only benefits the mortgage lender, there are a few benefits you can gain from PMI. For one, you stand a better chance of buying a house earlier. The extra safety net provided by mortgage insurance helps lenders to feel safer giving loans to people who pay smaller down payments. With PMI, lenders can approve a home loan with down payments as small as 3%. This decreased cost of entry also gives you more options for a home since you’re no longer tied to the 20% down requirement.
Being able to buy a new home quicker also gives you the advantage of building home equity earlier. Instead of paying rent during the time you’re saving up for a 20% down payment, you can use the money to build equity by paying your lender. Paying less down payment would also mean that you have more money saved up. Rather than exhausting your savings and leaving yourself financially vulnerable, you can build an emergency fund with the money you save.
Some mortgage insurance providers also offer protection options. Some insurance companies offer job loss protection as part of your PMI coverage, which allows your insurance policy to cover your mortgage payments until you find work again.
Depending on the insurance company you choose, they can also offer a safety net called a partial claim advance. A partial claim advance protects you from foreclosure by having the insurance company pay the lender if you default on your loan. While this means you have to pay money to the insurance company, this can allow you some breathing room and will reduce the risk of losing your house.
Reasons To Avoid PMI
Even if private mortgage insurance does have some benefits, having mortgage insurance means paying more on top of your mortgage payments. With a rate of 0.25 to 2 percent of your loan per year, that’s money given away mostly to protect your lender.
Despite ‘insurance’ implying that the insurance holder’s family receives monetary compensation if they die, the lender is the only beneficiary of the mortgage insurance. If you want to protect your family in case of anything, you need to have a separate insurance policy called mortgage protection life insurance.
Another fact to keep in mind is that private mortgage insurance isn’t tax-deductible since 2018, which means you’ll pay more tax by having PMI. Additionally, PMI isn’t easy to cancel. Many lenders require you to send in a written request to cancel your PMI, and the process can take several months. Also note that in this period, PMI still needs to be paid.
Tips To Avoid Paying PMI
Make a 20% down payment on your house so lenders don’t require you to get a PMI.
Shop around for cheaper homes to make sure you can pay 20% down on it.
Consider taking out a ‘piggyback mortgage’. This is a smaller loan that you take out with your first mortgage to increase your down payment.
Consider a jumbo non-conforming loan program where you don’t need PMI if your down payment is 10% or more.
Improve your home’s value through market appreciation and home improvement until you owe less than 80% of its value.
Look into mortgage and down payment assistance programs from your state’s housing finance agency. Some programs feature low down payment mortgages with reduced or no mortgage insurance.
If you’re a military veteran or service member, participate in the VA home loan program. These loans typically feature lower interest rates and no PMI.
Look into various no-PMI mortgage programs such as NACA, Bank of America’s Affordable Loan Solution, and CitiMortgage. While these programs may have no PMI, also consider the possibility of higher rates and higher credit score requirements.
Though you won’t avoid PMI entirely, consider lender-paid mortgage insurance. Note that this type of PMI usually has strict credit score requirements.
If you can’t avoid PMI entirely, improve your credit score so you pay less on PMI.
Ask your lender if there are other financing options that do not require PMI. Also consider shopping around for a credit union that’s willing to waive PMI.
If you’re in no urgency to buy a home and want to bypass PMI entirely, wait until you have enough for a 20% down payment.
Choosing to take mortgage insurance might allow you to buy a house quicker, but it’s important to consider the costs that will be incurred during the life of your loan. Whether you decide to take the PMI and buy your home early or to save up for a bigger down payment, the right decision will depend on your circumstances.
We understand that these options may be overwhelming, that’s why we’re here to assist! Reach out to us at Wesley LLC and our professionals will be more than happy to help you choose the option that best suits your needs.