If you’re making less than a 20% down payment on a home, it’s essential to understand your options for private mortgage insurance (PMI). Some people can’t afford a 20% down payment. Others may choose to put down a smaller down payment to have more cash on hand for repairs, remodeling, furnishings, and emergencies.
What is private mortgage insurance (PMI)?
Private mortgage insurance (PMI) is a type of insurance that a borrower may be required to purchase as a condition of a conventional mortgage loan. Most lenders require PMI when a homebuyer makes a down payment of less than 20% of the home’s purchase price.
When a borrower makes a down payment of less than 20% of the property’s value, the loan-to-value (LTV) of the mortgage is greater than 80% (the higher the LTV, the higher the risk profile of the mortgage). Mortgage for the lender).
Unlike most types of insurance, the policy protects the lender’s investment in the home, not the individual purchasing the insurance (the borrower). However, PMI makes it possible for some people to become homeowners sooner. For individuals who choose to put between 5% and 19.99% of the cost of the residence, the PMI allows them the possibility of obtaining financing.
However, it comes with additional monthly costs. Borrowers must pay their PMI until they have built up enough equity in the home that the lender no longer considers them high risk.
PMI costs can range from 0.25% to 2% of your loan balance per year, depending on the down payment and mortgage, the term of the loan, and the borrower’s credit score. The higher your risk factors, the higher the rate you will pay. And because PMI is a percentage of the mortgage amount, the more you borrow, the more PMI you’ll pay. There are several major PMI companies in the United States. They charge similar rates, which are adjusted annually.
While PMI is an added expense, so is continuing to spend money on rent and possibly missing out on market appreciation while you wait to save a more significant down payment. However, there’s no guarantee that you’ll come out ahead buying a home sooner rather than later, so it’s worth considering the value of paying PMI.
Some potential homeowners may need to consider mortgage insurance from the Federal Housing Administration (FHA). However, that only applies if you qualify for a loan from the Federal Housing Administration (FHA).
The key points
- You’ll need private mortgage insurance (PMI) if you’re buying a home with a down payment of less than 20% of the cost of the house.
- Please note that PMI is intended to protect the lender, not the borrower, against potential losses.
- You can purchase four main types of mortgage insurance: borrower-paid mortgage insurance, single-premium mortgage insurance, lender-paid mortgage insurance, and split-premium mortgage insurance.
- If you take out a loan from the Federal Housing Authority to purchase your home, you will need one additional type of insurance.
Private Mortgage Insurance (PMI) Coverage
First of all, you need to understand how PMI works. For example, suppose you put down 10% and take out a loan for the remaining 90% of the property’s value: $20,000 down and a loan of $180,000. With mortgage insurance, the lender’s losses are limited if the lender has to foreclose. If you lose your job and can’t make your payments for several months, that could happen.
The mortgage insurance company covers a certain percentage of the lender’s loss. For our example, let’s say that percentage is 25%. Therefore, if you still owed 85% ($170,000) of the purchase price of your $200,000 home at the time of foreclosure, instead of losing the entire $170,000, the lender would only lose $75% of the $170,000, or $127,500 of the home’s equity. The PMI would cover the other 25%, or $42,500. It would also cover 25% of the default interest accrued and 25% of the lender’s foreclosure costs.
If PMI protects the lender, you may wonder why the borrower must pay it. Essentially, the borrower compensates the lender for taking the greater risk of lending to you—instead of someone willing to put up a larger down payment.
How long do you have to purchase Private Mortgage Insurance (PMI)?
Borrowers can request their monthly mortgage insurance payments waived once the loan-to-value ratio falls below 80%. Once the mortgage loan-to-value ratio drops to 78%, the lender must automatically cancel PMI as long as you are current on your mortgage. This occurs when the down payment, plus the principal loan you’ve paid off, equals 22% of the home’s purchase price. This cancellation is a requirement of the Federal Homeowners Protection Act, even if the market value of your home has gone down.
Types of Private Mortgage Insurance (PMI)
1. Borrower Paid Mortgage Insurance
The most common type of PMI is Borrower Paid Mortgage Insurance (BPMI). BPMI comes in an additional monthly fee that you pay with your mortgage payment. After your loan closes, you pay BPMI every month until you have 22% equity in your home (based on the original purchase price).
At that time, the lender should automatically cancel the BPMI, provided you are current on your mortgage payments. Accumulating enough home equity through regular monthly mortgage payments for BPMI to be paid off typically takes about 11 years.
You can also be proactive and ask the lender to cancel the BPMI when you have 20% equity in your home. For your lender to cancel BPMI, your mortgage payments must be current. You must also have a satisfactory payment history, and there must be no additional liens on your property. In some cases, you may need a current appraisal to substantiate the value of your home.
Some loan servicers may allow borrowers to pay off PMI sooner based on home value appreciation. Assume the borrower accumulates 25% equity due to preference in years two through five, or 20% equity after year five. In that case, the investor who purchased the loan may allow the PMI to be canceled after the home’s increased value is demonstrated. That can be done with an appraisal, a broker price opinion (BPO), or an automated valuation model (AVM).
You may also be able to get rid of PMI early by refinancing. However, you will need to weigh the cost of refinancing against the costs of continuing to pay mortgage insurance premiums. You may also be able to pay off PMI early by prepaying the principal on your mortgage, so you have at least 20% equity.
It’s worth considering if you’re willing to pay PMI up to 11 years to buy now. What will PMI cost you in the long run? What will it potentially cost you to wait to buy? While it’s true that you’ll miss out on building equity in your home while it’s rented, you’ll also avoid the many costs of homeownership. These costs include homeowner’s insurance, property taxes, maintenance, and repairs.
The other three types of PMI are not as common as borrower-paid mortgage insurance. You may want to know how they work, in case one of them sounds more appealing, or your lender presents you with more than one mortgage insurance option.
2. Single-Premium Mortgage Insurance
With single-premium mortgage insurance (SPMI), also called lump-sum mortgage insurance, you pay for mortgage insurance upfront in a lump sum. This can be done in full at closing or mortgage financed (in the latter case, it may be called single finance mortgage insurance).
The benefit of SPMI is that your monthly payment will be lower compared to BPMI. That can help you qualify for more loans to buy your home. Another advantage is that you don’t have to worry about refinancing to get out of PMI. You also don’t have to keep an eye on your loan-to-value ratio to see when you can cancel PMI.
The risk is that if you refinance or sell within a few years, none of the one-time premia is refundable. Plus, if you finance the single premium, you’ll pay interest on it for as long as you keep the mortgage. Also, if you don’t have enough money for a 20% down payment, you may not have the cash to pay a one-time premium upfront.
However, the seller or, in the case of a new home, the builder may pay for the borrower’s single-premium mortgage insurance. He can always try to negotiate it as part of his purchase offer.
Single-premium mortgage insurance can save you money if you plan to stay in the home for three or more years. Ask your loan officer to see if this is the case. Keep in mind that not all lenders offer single-premium mortgage insurance.
3. With Lender Paid Mortgage Insurance (LPMI)
your lender will technically pay the mortgage insurance premium. You’ll pay it back over the life of the loan in the form of a slightly higher interest rate.
BPMI, you can’t cancel LPMI when your net worth reaches 78% because it’s built Unlike into the loan. Refinancing will be the only way to lower your monthly payment. Your interest rate will not decrease once you have 20% or 22% equity. PMI paid by the lender is non-refundable.
The benefit of PMI paid by the lender, despite the higher interest rate, is that your monthly payment could still be lower than making monthly PMI payments. In this way, you could qualify for a larger loan.
4. Split Premium Mortgage Insurance
Split-premium mortgage insurance is the least common type. It is a hybrid of the first two types discussed: BPMI and SPMI.
Here’s how it works: You pay part of the mortgage insurance as a lump sum at closing and interest monthly. You don’t have to put up as much extra money upfront as you would with SPMI, nor does it increase your monthly payment as much as it would with BPMI.
One reason to choose split-premium mortgage insurance is a high debt-to-income ratio. When that’s the case, raising your BPMI monthly payment too much would mean you won’t qualify to borrow enough to buy the home you want.
The initial premium could range between 0.50% and 1.25% of the loan amount. The monthly premium will be based on the net loan-to-value ratio before considering any financed premium.
As with SPMI, you can ask the builder or seller to pay the initial premium, or you can build it into your mortgage. Split premiums may be partially refundable once mortgage insurance is canceled or terminated.
5. Federal Mortgage Protection for Home Loans (MIP)
There is an additional type of mortgage insurance. However, it is only used with loans underwritten by the Federal Housing Administration. These loans are better known as FHA loans or FHA mortgages. PMI through the FHA is known as MIP. It is a requirement for all FHA loans with down payments of 10% or less.
Also, it cannot be eliminated without refinancing the home. The MIP requires a down payment and monthly premiums (usually added to the monthly mortgage note). The buyer is still required to wait 11 years before removing the MIP from the loan if they had a down payment of more than 10%.
Cost of Private Mortgage Insurance (PMI)
The cost of your PMI premiums will depend on several factors.
- The premium plan you choose
- Whether your interest rate is fixed or adjustable
- Your loan term (typically 15 or 30 years)
- Your down payment or loan-to-value (LTV) ratio (a 5% down payment gives you a 95% LTV; a 10% down payment makes your LTV 90%)
- The amount of mortgage insurance coverage required by the lender or investor (can range from 6% to 35%)
- Whether the premium is refundable or not
- Your credit score
- Any additional risk factors, such as whether the loan is for a jumbo mortgage, investment property, cash refinance, or second home
- In general, the more risky you appear based on any of these factors (which are usually taken into account whenever you take out a loan), the higher your premiums will be. For example, the lower your credit score and the lower your down payment, the higher your premiums.
- According to data from Ginnie Mae and the Urban Institute, the average annual PMI typically ranges from 0.55% to 2.25% of the original loan amount each year. Here are some scenarios: If you put a 15% down payment on a 15-year fixed-rate mortgage and have a credit score of 760 or higher, for example, you would pay 0.17% because you would likely be considered a low-income borrower. Risk. If you put a 3% down on a 30-year variable-rate mortgage with an introductory rate that is fixed for only three years and you have a credit score of 630, your rate will be 2.81%. That’s because you would be considered a high-risk borrower by most financial institutions.
- Once you know what percentage applies to your situation, multiply it by the amount you’re borrowing. Then divide that amount by 12 to see what you’ll pay each month. For example, a $200,000 loan with an annual premium of 0.65% would cost $1,300 per year ($200,000 x 0.0065), or about $108 per month ($1,300 / 12).
Estimated Private Mortgage Insurance (PMI) Rates
- Many companies offer mortgage insurance. Your rates may differ slightly, and your lender—not you—will select the insurer. However, you can get an idea of the rate you’ll pay by looking at the mortgage insurance rate card. MGIC, Radian, Essent, National MI, United Guaranty, and Genworth are the leading private mortgage insurance providers.
- Mortgage insurance rate cards can be confusing at first glance. Here’s how to use them.
Look for the column that corresponds to your credit score.
Find the row that corresponds to your LTV ratio.
Identify the applicable line of coverage. Search the web for Fannie Mae mortgage insurance coverage requirements to identify how much coverage is required for your loan. Alternatively, you can ask your lender (and impress them with your knowledge of how PMI works).
Identify the PMI rate that corresponds to the intersection of your credit score, down payment, and coverage.
If applicable, add or subtract from that rate the amount from the adjustment table (below the main rate table) that corresponds to your credit score. For example, if you’re doing cash refinance and your credit score is 720, you could add 0.20 to your rate.
As we showed in the previous section, multiply the total rate by the amount you’re borrowing; this is your annual mortgage insurance premium. Divide it by 12 to get your monthly mortgage insurance premium.
Your rate will be the same every month, although some insurers lower it after ten years. However, that’s just before the point where you should drop coverage so that any savings won’t be that significant.
Federal Housing Administration (FHA) mortgage insurance
- Mortgage insurance works differently with FHA loans. For most borrowers, it will end up being more expensive than PMI.
- PMI does not require you to pay a premium upfront unless you choose single-premium or split-premium mortgage insurance. You will not pay any monthly mortgage insurance premium for single premium mortgage insurance. In the case of split-premium mortgage insurance, you’ll pay lower monthly mortgage insurance premiums because you’ve paid a premium upfront. However, everyone must pay a premium upfront with FHA mortgage insurance. What’s more, that payment does nothing to lower your monthly premiums.
- As of August 2020, the advance mortgage insurance premium (UFMIP) is 1.75% of the loan amount. You can pay this amount at closing or finance it as part of your mortgage. The UFMIP will cost you $1,750 for every $100,000 you borrow. If you invest it, you’ll also pay interest, making it more expensive over time. The seller is allowed to pay your UFMIP as long as the seller’s total contribution to your closing costs does not exceed 6% of the purchase price.
- With an FHA mortgage, you’ll also pay a monthly mortgage insurance premium (MIP) of 0.45% to 1.05% of the loan amount based on your down payment and the term of the loan. As the FHA table shows, if you have a $200,000 30-year loan and pay the FHA minimum down payment of 3.5%, your MIP will be 0.85% for the life of the loan. Not being able to cancel your MIPs can be costly.