You’ve been working for weeks on documents to submit your mortgage application. Now that you’ve been approved for the loan now is the time to discuss numbers.
When you first look at the document that outlines the details of your monthly mortgage payment, the word PMI grabs your attention. It’s about $100 per month but you’re not sure of the purpose.
Based on what you’ve read about it that it’s a requirement for loans when the borrower has very little or no money down. But before you get scared take an exhale and read more about PMI and how it operates.
What is private mortgage insurance (PMI)?
What happens if your down amount is less than 20% of the total cost of the new house? You could be eligible to get a mortgage loan. However, you’re at a greater risk of risk to the lender as you’re starting with zero equity in the home. If you’re in debt on your monthly payment and the lender closes on the property they could lose money on the sale.
However, the 20% down payment can be a way to generate instant equity in your home. It also provides a level of protection for the lender in the event that they need to sell their home at an uninvolved price to recover losses.
So, how can the lender safeguard themselves in the event that you have a small or the amount of a down payment? This is the reason why PMI, also known as private mortgage insurance (PMI) is available.
PMI is a form of mortgage insurance that shields the lender from having to take the loss in case you default in repayment of the loan. If the lender is not able to recover the amount of the loan by selling the property, PMI will kick in and pay the difference. PMI should not be confused with homeowners insurance which shields you from damages to your property.
Who pays for private mortgage insurance?
This protection is at a cost to the borrowers. However, it permits those who have a down payment lower than 20% to acquire the house that they’ve always wanted. It also reduces the risk for lenders, allowing them to extend these kinds of loans to homeowners.
Does it cover private and public lenders?
PMI is only accessible only to private lenders. The government and other lenders of public nature have their own versions of mortgage insurance.
When is private mortgage insurance required?
Mortgage lenders use the loan-to value (LTV) ratio to decide if the borrower is required to pay PMI. In general, you’ll be required to pay PMI premiums if the loan-to-value ratio is higher than 80percent. To determine the mortgage LTV the lender will divide the mortgage amount by home’s value.
Other factors could cause the lender to request PMI coverage. This could include foreclosures in the past or a credit score that is not perfect or any other circumstances that the lender believes will increase the likelihood of you defaulting with the loan.
A few scenarios:
| SCENARIO 1 | SCENARIO 2 | SCENARIO 3 | |
| Home Value [1] | $100,000 | $200,000 | $250,000 |
| Down Payment | $10,000 | $50,000 | $25,000 |
| Mortgage Amount | $90,000 | $50,000 | $25,000 |
| Loan to Value Ratio | 90% | 75% | 90% |
| PMI Required | Yes | No [2] | Yes |
[2]: This may change if the lender determines the borrower is riskier than normal
Private Mortgage Insurance vs. Mortgage Insurance Premiums
As mentioned earlier, mortgage insurance comes in a few variations:
- Private Mortgage Insurance (PMI): protects private lenders who make conventional loans. There are two types of PMI for conventional loans:borrower-paid mortgage insurance and lender-paid mortgage insurance. In most cases, PMI only applies until your LTV reaches 80%. However, in some cases, the lender will require a higher percentage to uninsure the loan.
- Mortgage Insurance Premium (MIP):
- Protects government-backed VA loans and FHA loans. You pay a portion of the premium at the end of the VA loan or FHA loan. Then, you continue to pay monthly mortgage insurance premiums even when the LTV is less than 80%.
The LTV ratio is calculated the same way for both private and government-backed mortgage products.
How much does PMI cost?
Premiums vary by loan. On average, you can expect to pay between 0.5% and 1% of your loan amount each year. So if your mortgage is $350,000 and your PMI rate is 0.8 percent, your annual premium will be around $2,800, or $233.33 per month.
The insurance company will analyze your profile, including your credit score and down payment, to determine your rate.
The type of mortgage will also affect your premium. For example, if you choose an adjustable-rate mortgage with a variable rate, your premium may be higher. Why is that? If interest rates go up, so will your monthly payments. There’s a chance you’ll fall behind on your mortgage payments.
The state of the real estate market in your area will also affect your PMI premium. If projections show that home values will plummet in the future, your premium could be higher. This is because once you’re upside down on your loan, you’re likely to walk away.
How are PMI premiums paid?
There are three ways to make PMI premium payments:
- Borrower-Paid PMI: Most mortgage lenders make it easy to manage premiums by rolling monthly debt into the amount you’ve already paid for your home. This is the method most borrowers use.
- Single Premium PMI: You can also make a lump sum payment at the beginning of the loan by paying cash or rolling the total premium amount into the loan.
- Lender Paid PMI: Lender-paid PMI is also an option if you want to lower your monthly mortgage payment. The lender will pay the premiums on your behalf. But remember, the cost will be recovered in the form of interest. Premiums don’t automatically disappear when the LTV of the mortgage reaches 80%.
How to Avoid Paying Private Mortgage Insurance?
The easiest way to avoid paying PMI is to make a larger down payment. If you can’t afford a 20% down payment, it will lower your LTV ratio. Plus, you can drop your insurance faster.
1.apply for a second mortgage or collateral loan
To use this strategy effectively, you’ll need to take out a mortgage with the purchase price of the home minus 20%. The remaining balance of the loan, minus the down payment, is then rolled over into a second mortgage or incidental loan.
So, if you bought a home for $200,000 and made a $15,000 down payment, the first mortgage would be $160,000 dollars. The second mortgage would be $25,000 because you made a $15,000 down payment.
Using this method, you can avoid PMI because the first mortgage has an LTV ratio of 80%. But remember, the second mortgage has a higher interest rate. So, sooner or later, you’ll want to pay it off to avoid spending a ton of money on interest.
2.Monitor the loan-to-value ratio
When you apply for a mortgage, your lender uses the purchase price of the home to determine the LTV ratio. However, an increase in the market value of your home may mean that you are no longer obligated to pay PMI.
Under the Homeowner ‘s Protection Act (HPA), PMI must be canceled once the outstanding principal reaches 78% of the original loan amount.
Be prepared to provide the lender with a professional appraisal to substantiate your claim. You may spend hundreds of dollars to do this, but the savings will be worth it.
3.Request PMI Cancellation
If your PMI is close to 80%, the lender may be willing to remove PMI from your loan. however, it is also possible that you have met some other conditions that would require the removal of the PMI overlay.
4.Refinance your mortgage
Maybe your credit score is so bad that you were forced to apply for a government-backed loan that requires you to hold PMI for the life of the loan. or, you may be stuck with a conventional loan from a private lender that requires PMI until the LTV ratio reaches 70%.
Either way, refinancing your loan with looser PMI limits may be a better option. But be sure to run the numbers to confirm that the new loan won’t cost you more. (Remember, extending or resetting the term of the loan gives the lender more time to charge you interest).
5.Shop for a loan that doesn’t require PMI
Compare loan programs and find one that doesn’t require PMI. For example, VA loans don’t require PMI, which can save you a ton of money. Also, explore loans guaranteed by the Federal Housing Administration (FHA) or the U.S. Department of Agriculture (USDA). Both companies offer programs designed to make homeownership easier for low- and moderate-income homebuyers.
Some lenders also offer mortgage products that allow you to make a small down payment without having to pay PMI; Bank of America’s Affordable Loan Solutions mortgage product is a good example.
6.Ask about exemptions
If you’re a doctor or veteran, you may be exempt from paying PMI even if you don’t have 20% down, and ask your lender for more details to determine if you qualify.
7.consult with your lender
Still no luck? Contact your lender and ask about other ways to stop paying PMI. They may know tips and tricks on how to get out of PMI that may not be obvious to the average borrower.
Finally, if you still have questions or don’t understand how mortgage insurance works, seek clarification before signing. That way, you won’t have any surprises later.
FAQs
When is private mortgage insurance required?
PMI is typically required when a borrower makes a down payment of less than 20% of the purchase price of the home.
What is the cost of Private Mortgage Insurance?
The cost of PMI depends on the size of the loan and the amount of the down payment. Generally, PMI costs between 0.5% – 1.5% of the loan amount.
How long do I have to pay for PMI?
Generally, PMI is required until the loan-to-value (LTV) ratio reaches 78% Once the LTV reaches 78%, the lender must automatically cancel the PMI.
How can I avoid PMI?
Borrowers can avoid PMI by paying at least 20% of the purchase price of the home.In addition, some lenders offer programs that allow borrowers to avoid PMI with as little as a 20% down payment.
What if I want to cancel PMI?
Once the loan-to-value (LTV) ratio reaches 80%, the borrower can apply to cancel PMI.The lender may need to prove that the LTV has reached 80% before canceling PMI.
Can I deduct PMI on my taxes?
As of 2019, PMI is not tax-deductible. However, borrowers can deduct the interest portion of their mortgage payments, which may include PMI.
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