Private Mortgage Insurance (PMI) 

When you think about buying a home, some expenses that come to mind are the down payment and closing costs. The latter is broad and often entails expenses like title search, attorney fees, and insurance. Like most people, you probably want to reduce costs as much as you can, but you can only do that when you know your options.

When calculating costs, there are two common types of insurance to keep in mind; homeowner’s insurance and private mortgage insurance. The former protects your property from losses and damages, while the latter protects the lender if you default on the home.

Whether you have to pay private mortgage insurance depends on how much you put down at closing and the health of your finances. Here is everything you need to know about private mortgage insurance, including how to avoid it.

What is private mortgage insurance (PMI)?

Private mortgage insurance is a type of insurance that some lenders require you to get with a mortgage loan. Some people confuse this with FHA mortgage insurance, but the two are different. FHA mortgage insurance is an additional fee you pay to protect loans insured by the Federal Housing Administration, but unlike PMI, you pay two different fees. We’ll discuss this in more detail below.

What is PMI for?

In short, PMI is a way for lenders to protect their investment in a home if you foreclose. It’s important to note that (PMI) doesn’t protect you as the borrower––that’s what homeowner’s insurance does.

Is PMI always required? When the down payment is less than 20%, PMI is usually required except in special circumstances. Lenders aim to keep their loan-to-value ratio (amount you borrow compared to total value of home) below 80%, as it gives them more confidence you’ll repay the loan. However, when you pay less than 20%, it makes you a riskier borrower, hence the need for PMI.  So, for example, if you buy a home $120,000 home and put 15% ($18,000) down at closing, your LTV is 85%. You’d then need to pay PMI until that ratio falls below 80%.

So then, why get mortgage insurance if it doesn’t cover you? It makes it easier for people with a down payment smaller than 20% to buy a home. Depending on the type of PMI you opt for, you’re expected to continue paying until you’ve accumulated enough equity on your new home––usually 20%––to reduce your risk as a borrower.

PMI Coverage

Knowing what PMI covers and what it doesn’t is important when purchasing a home. Your hard-earned money is going into paying these fees, so you should understand how it’s used.

As mentioned earlier, PMI covers the lender, not the buyer. It covers a percentage of:

• The home’s principal
• The delinquent interest accrued
• Lender’s foreclosure costs

Let’s say you lost your job, had to foreclose on your home, and PMI covers 30% of your lender’s loss. If you bought the house at $300,000 and still owed 90% of the home when going into foreclosure ($270,000), the lender would get back $81,000.

Thus, they’d only lose 70% of the $300,000 you had left to pay as opposed to 100%. Besides this, they’ll also get back a percentage of the items mentioned above; the amount depends on the PMI company used.

As the borrower, you cannot choose your PMI provider––the lender does that. However, you can do some research to see which PMI providers your lender offers and compare rates. You could then request one you qualify for if you feel they’ll offer more favorable terms.

How Long Do You Have to Buy PMI?

If you get a private or conventional mortgage loan, you can usually cancel PMI once you’ve met certain requirements in terms of equity and your LTV ratio. Here are a few instances where you should be able to cancel your PMI.

1. Home Equity Surpasses 22%

It is possible to get out of private mortgage insurance once your LTV reaches 78%. Thanks to the Homeowners Protection Act, as long as you’re up to speed on payments, the lender must cancel payments at this point. As a rule of thumb, it could take up to 11 years to reach that LTV depending on your payment plan. Also, note you can request they cancel your PMI at 20%, but the lender could deny your request if you don’t have a good payment history or have liens on the property.

2. Home Value Appreciates

Another exception is if your home’s value goes up or appreciates, and your equity rises to 20% or more. In this case, you’d possibly need a current appraisal, broker’s price opinion, or automated valuation model to confirm your home’s value.

3. Refinancing

Some people refinance their homes to get rid of PMI. However, calculate the cost of refinancing to ensure it’s worthwhile considering you have to pay closing costs again. If care isn’t taken, you could end up paying more to refinance than you would by continuing to pay private mortgage insurance.

4. Prepaying Mortgage Principal

When you prepay your mortgage principal, you’re simply making extra payments on your loan balance every month. This not only saves you money on interest, but it helps you build up equity quicker. If you can prepay enough of your principal, you’ll surpass 20% equity, meaning you no longer have to pay PMI.

Types of PMI

There isn’t just one type of PMI, so you have options when it comes to paying it. Your financial circumstances will determine which is best for you; some are more cost-effective than others.

Borrower-Paid Mortgage Insurance (BPMI)

This is the most common type of PMI. You pay it in monthly installments until you have 22% equity on your home. The payment can be included in your mortgage payment each month or you can pay it separately.

Single-Premium Mortgage Insurance (SPMI)

If you can afford it, paying PMI in a lump sum is an option; you pay the total sum at closing. Another trick is to try negotiating the cost of SPMI and getting the seller to cover some, if not all of the cost.

Some downsides to SPMI are:

• If you refinance or sell before you achieve 20% equity, you could lose money
• If you finance to pay the SPMI, you must continue paying interest for the life of the mortgage

If you have the money to pay SPMI upfront, consider putting that money towards a down payment instead. If you’re close to the 20% mark it may be worthwhile, so you can forget paying PMI altogether.

Lender-paid Mortgage Insurance (LPMI)

This is what it sounds like, the lender pays the mortgage insurance premium. What’s the catch? You pay a higher interest rate, which means you’re technically still paying for it. For this reason, you can’t cancel LPMI when your loan-to-value ratio reaches 78%, and your interest rate doesn’t decrease either.

The only way to get out of this type of mortgage insurance is to refinance your loan. So what then is the benefit? Your monthly payments could still work out lower than if you were paying PMI monthly.

Split Premium Mortgage Insurance

This is a mixture of BPMI and SPMI. You pay a sum at closing (0.50%-1.25% of the loan amount) and the balance monthly. The upside to this type of PMI is you don’t have to come up with the entire lump sum at closing, and you don’t end up paying as much in monthly payments.

Aside from the cost-saving benefits, SPMI is good for people with a high debt-to-income ratio. For instance, if you used BPMI, it could cause a high monthly payment, which could mean you don’t qualify for a mortgage you want. However, with split premium mortgage insurance, you lower your monthly payments, thus lowering your debt-to-income ratio.

With this type of MPI, it’s also in your interest to see if the seller will pay the upfront sum, so you only have to pay the balance monthly.

Cost of PMI

PMI increases the cost of your monthly mortgage payments and can make the overall loan more expensive. In terms of how much it costs, that varies. It could cost anywhere from 0.5%-1.5% of the loan amount yearly. At these rates, you’d pay between $500-$1,500 per year for PMI on a $100,000 mortgage.

According to a Freddie Mac estimate, you should expect to pay from $30-$70 monthly for every $100,000 you borrow.

You should note that some PMI plans are refundable. If you have a refundable PMI and don’t default on your loan, you could get money back within 45 days of canceling.

Estimating Rates for PMI

To give you a better understanding of PMI rates and how it would affect you as a buyer, here’s another real-life example.

If you’re a buyer who wants a $400,000 home but only has a 12% down payment ($48,000) and has a below-average credit score, the lender could offer you PMI on the higher side. If the lender gave it to you at 1.5%, your PMI would be $6,000 a year or $500 monthly.

Some factors that influence the rate of your PMI include:

• Down payment amount
• Loan-to-value ratio
• Whether you have a fixed or adjustable interest rate
• Your credit score
• How much you borrow
• The PMI company you use
• Amount of PMI lender requires

Typically, borrowers seen as less risky pay lower rates. So in sum, to get lower PMI rates, ensure your credit score is in good shape and put down as much down payment as you can.

FHA Mortgage Insurance

FHA loans and USDA loans don’t require private mortgage insurance. However, you may have to get a different type of mortgage insurance premium called FHA mortgage insurance or MIP.

There are two forms of insurance premiums for FHA loans; one you have to pay upfront and the other annually. Both are required, no matter how much your down payment is. While FHA mortgage insurance rates are sometimes lower than PMI, it’s still an additional cost.

You should also know VA loans don’t require any type of mortgage insurance at all, regardless of the down payment size. Instead, you pay a one-time VA funding fee.

Rates

Upfront premium: The current upfront mortgage premium on FHA loans is 1.75% of the base loan amount. You can choose to pay it at closing or roll the cost into your monthly payment. You may get a refund on this payment if you don’t default on the loan.

Monthly premium: In addition to an upfront premium, you’re required to pay a monthly premium, too. This rate can range from 0.45% to 1.05% of the loan amount yearly.

The length of your loan can also influence your annual MIP rate. For instance, if you take out a loan under $625,500 with a term of over 15 years, and put down a down payment higher than 5%, your annual mortgage insurance would be 0.80%. However, if you put a down payment below 5%, your MIP goes up to 0.85%.

Cancellation

Anyone assigned an FHA case number on or after June 3, 2013, has to pay MIP for at least 11 years if they make a down payment over 10%. Those with a down payment less than 10% must pay MIP for the entire loan term. The only way to get rid of it earlier is to refinance to a conventional loan or sell the home.

Advantages of PMI

It can appear there are no advantages of PMI as you’re paying to protect the lender’s investment, but there are a few upsides.

One is that PMI is tax-deductible for the years 2018, 2019, and 2020. That said, if your adjusted gross income surpasses $109,000 or $54,500 when married and filing separately, you can’t deduct mortgage insurance premiums. Also, you can only get the PMI deduction if you itemize your deductions.

Another advantage is those with deposits on the smaller side can climb on the homeownership ladder quicker. While it isn’t a rush to buy a home, it’s beneficial to those who want to get started on building equity and long-term wealth.

That said, it’s best to weigh out the costs of waiting until you have a down payment of 20% or higher to buy or paying with a smaller deposit and paying PMI.