What is private mortgage insurance (and how can I avoid it)?
When it comes to purchasing a home, the traditional belief was that a 20% down payment was necessary. However, saving up that much can be tough, especially for first-time homebuyers or anyone looking to enter today's housing market quickly.
This is where private mortgage insurance (PMI) comes into play, offering an alternative for borrowers who don't have a sizeable down payment.
What is private mortgage insurance, and why should I care?
If you're like most Americans — and you're not Jay-Z and Beyonce rich — you probably need to borrow money to buy a house. And if you're making a down payment of less than 20%, the company lending you that money needs to protect itself.
PMI is insurance that benefits the lender by protecting them in case you default on your future mortgage payments. But how do you — the prospective homebuyer — benefit from taking on private mortgage insurance?
By paying a monthly mortgage insurance cost, PMI allows you to secure a mortgage and enter the housing market sooner than if you had to wait until you saved up for a full 20% down payment. It also allows you to start building equity and enjoy being a homeowner immediately.
Understanding how PMI works
While PMI allows buyers to enter the housing market with a lower down payment, there is a downside. For a time, you'll have slightly higher monthly mortgage payments since you'll end up borrowing more initially. However, in most cases, PMI doesn't remain in effect for the entire loan term. Once your equity in the home reaches 20% through a combination of mortgage payments and property value appreciation, you can request it go away.
That said, before falling in love with a home or settling on a home loan, it's important to speak with your loan officer about the PMI costs based on your unique financial situation. And it's equally important to understand what factors contribute to how much you're going to have to pay for PMI.
Things that affect private mortgage insurance include:
- Type of residence: Are you looking to buy a single-family home, a condo, a townhouse or an investment property? This will impact the PMI costs.
- Type of loan: Different loan types, such as conventional loans or government-backed loans, may have varying PMI requirements and costs.
- Length of the loan term: Are you considering a 15-year or 30-year term?
- Credit score: This is a biggie. Generally, with a higher score, you're less of a risk to the lender, so your monthly premiums will be lower.
- Interest rate: This affects the overall cost of your mortgage, including the PMI premiums you'll be responsible for.
- Amount of down payment: A larger down payment often leads to lower PMI premiums.
- Loan-to-value ratio (LTV): Lowering your LTV (the loan amount divided by the appraised property value) generally results in smaller PMI payouts.
- PMI type offered: Different lenders may offer various kinds of PMI, each with its own cost structure. You can read more about this below.
- Is it cancellable? Some lenders allow for refunds or cancellations under certain conditions, and that can affect initial pricing.
What will your PMI cost?
What you pay for private mortgage insurance will differ from what your neighbor pays. But you can expect to pay at least 0.5% of the amount you're borrowing, although it can go to nearly 2% depending on the factors we covered in the last section.
To calculate your annual PMI payment, you'll need to know the specific PMI rate for your loan. This is usually presented as an annual percentage rate (APR).
If we assume a PMI rate of 1% and a $450,000 loan amount, the annual PMI payment can be calculated as loan amount × PMI rate, or $450,000 × 0.01. Do the math, and you'll see that you would pay $4,500 annually for PMI. That's about $375 a month.
Keep in mind that this is a hypothetical example and that your actual PMI rate will vary, so it's important to consult with your mortgage provider to get an accurate estimate based on your specific situation.
Common types of PMI
Knowing the various types of available private mortgage insurance options will help you make a more informed decision that aligns with your immediate home buying — and future financial — goals.
Borrower-Paid Mortgage Insurance (BPMI):
This is where you pay the insurance premium as part of your monthly mortgage payment because you put down less than 20%. Once your equity reaches 80%, you can request it be canceled.
Lender-Paid Mortgage Insurance (LPMI):
This is where the lender pays for the mortgage insurance upfront — but in return, you may have a slightly higher interest rate. And unlike BPMI, LPMI is not cancellable.
Single Premium Mortgage Insurance (SPMI):
If you have the cash, you can eliminate monthly PMI payments by paying a lump sum at closing. Just consider how this might impact other costs you'll have after moving in.
Split-Premium Mortgage Insurance:
In this scenario, you pay a portion of the PMI premium at closing, which reduces your future obligations — basically, you're combining upfront and monthly payments.
Can you avoid paying PMI?
Saving for a 20% down payment is the best way to avoid PMI. However, if that's not possible, government-insured loans, like an FHA loan, a VA loan or a USDA loan, can be an option. PMI is a built-in part of those programs, whether through an upfront premium, an annual mortgage insurance payment or a funding fee instead of traditional PMI.
If you have no choice other than to take out a loan with PMI, ask for one with terms that allow you to cancel as soon as you have 20% equity in the house or an LTV of 80%.
To initiate a request to remove your PMI, your lender will typically require you to make your request in writing. Speak to your loan officer about any eligibility requirements they may have.
Typical ones include:
- Being current on your mortgage payments.
- Having no payments made 30 days or more past due in the previous 12 months — or 60 days or more past due in the last 24 months.
- The mortgage loan must meet the applicable loan-to-value ratio (LTV).
You may also be able to get rid of PMI by refinancing your loan.
Need more info on PMI?
As you can see, PMI is useful for homebuyers to get a property with a smaller down payment. But knowing the types, costs and alternatives of PMI is crucial for informed homeownership choices.
If you're a prospective homebuyer with a question about private mortgage insurance, talk to a Movement Mortgage loan officer to discuss your options. Or, if you're ready to get started now, you can always apply online!