Private mortgage insurance (PMI) is a particular type of insurance policy private insurers provide to protect a lender against loss if the borrower defaults. Most lenders require Private Mortgage Insurance PMI when a buyer puts down less than 20% of the home’s purchase price or, in mortgage terms, the mortgage’s loan-to-value ratio exceeds 80% (the higher the LTV ratio), the higher the risk profile of the mortgage). PMI allows borrowers to obtain financing if they can only afford (or prefer) to pay only 5% to 19.99% of the cost of the residence, but it has additional monthly charges.
PMI costs can range from 0.25% to 2% (but typically 0.5% to 1%) of your loan balance per year, depending on the size of the down payment and mortgage, the loan term, and your credit score. The higher your risk factors, the higher the rate you pay. Also, since PMI is a percentage of the loan amount, the more you borrow, the more PMI you will pay. There are six major PMI companies in the United States. They charge similar rates, which are adjusted annually.
How long is the PMI?
Once the mortgage’s LTV drops to 78%—that is, your down payment plus the loan’s ‘paid principal’ equals 22% of the home’s purchase price—the lender must automatically cancel PMI as required by law even if your home’s market value has decreased (as long as you’re current on your mortgage), federal homeowners protection.
Otherwise, the amount of time PMI should take depends on the type of PMI you choose.
Types of PMI
There are three different types of private mortgage insurance:
- Borrower Paid PMI (BPMI): You pay a premium each month until your PMI is terminated (when your LTV balance is scheduled to reach 78% of your home’s original value) or when it is canceled at your request. When borrowers have achieved 20% equity in the house, they can notify the lender in writing that it is time to discontinue PMI premiums. Lenders must provide the buyer with a written statement at closing announcing how many years and months it will take them to pay off 20% of the principal. Still, it could happen sooner due to home price appreciation (verified by an appraisal) or because you have made additional principal payments. The lender must comply as long as the value of your home has not decreased, you have a history of timely payments, and certify that you do not have a second mortgage or subordinate lien on the property. You can also request cancellation or when you reach the midpoint of the amortization period (a 30-year loan, for example, would contact the center after 15 years).
- Single-Premium PMI: You pay for mortgage insurance upfront in a single lump sum, eliminating the need for a monthly PMI payment. The single premium can be paid in full at closing or financed into the mortgage. While it does require more of an initial outlay, this option can save homeowners money in the long run.
- Lender Paid PMI (LPMI) – The lender pays private mortgage insurance on behalf of the borrower. This may result in a lower monthly mortgage payment. Still, you may end up paying more in interest over the life of the loan, especially since rates are typically higher for this type of PMI (as its cost is included in the interest rate). Mortgage for the life of the loan). Unlike BPMI, you cannot cancel LPMI because it is a permanent part of the loan.
PMI Cancellation
With BPMI, it’s essential to keep track of your mortgage payments and your equity buildup. That 78% threshold for automatic termination is based on the date, the LTV is scheduled to reach 78%, according to your amortization schedule, not your actual payments. That means if you made extra payments and went the 78% threshold ahead of schedule, your lender doesn’t have to finish PMI until the initially scheduled date, which could leave you with months, or even years, of unnecessary PMI payments. (By law, lenders must tell you about your general right to cancel PMI, but not when you can see in particular.)
It would be best not to count on the lender to know that your home equity has reached 20% of your original purchase price or current appraised value. If so, then you have the responsibility to request cancellation. To apply for cancellation, you must be present on your mortgage payments and have a good payment record; specifically, that it has:
- You did not make a payment that is 60 days or more past due within the first 12 months of the last two years before the date of cancellation (or the date you request cancellation, whichever is later); or
- You did not make a payment that is 30 days or more past due within 12 months before the date of cancellation (or the date you request cancellation, whichever is later).
Paying off your mortgage isn’t the only way to build up the equity that allows you to request a discharge. Making improvements that add enough value to your home can also bring you down to the minimum required. If you’re doing a major renovation—a significant kitchen remodel, for example—check the numbers to see if you now qualify for a written PMI cancellation request.
Once PMI has been canceled, the lender may not require further PMI payments more than 30 days after your written request was received or the date you met the evidence and certification requirements, whichever happens later.
PMI vs. MIP: the difference between private mortgage insurance and mortgage insurance premium
Technically, the PMI only applies to conventional loans. Federal Housing Administration loans have their mortgage insurance with different requirements.
FHA loans are similar to PMI loans in that they require the borrower to pay mortgage insurance in addition to regular mortgage payments. But this insurance, known as the mortgage insurance premium (MIP), requires an initial fee at closing and a monthly compensation for a set number of years; it is paid directly to the U.S. Department of Housing and Urban Development (HUD). FHA loans also differ in that they are available to borrowers with less than perfect credit, allowing down payments as low as 3.5% of the purchase price and cannot be used for investment or second homes.
MIPs are usually suspended under the same conditions as PMIs. However, your lender may be legally entitled to continue to require it on your FHA loan in several circumstances:
- When you made payments more than 30 days late in the previous year and more than 60 days late in the last two years, your lender may continue to consider you a high-risk borrower. Your lender may come to the same conclusion when your current credit score is meager.
- Suppose you have a second mortgage on your property, such as a home equity loan. The thinking is that if you have a higher debt-to-loan ratio, you are more likely to default.
- The value of your home has drastically decreased since the FHA loan was issued, so your LTV remains 80% or more using its current market value.
What influences does PMI rate?
Your rate will depend on several factors, including:
- Size of your advance. PMI will cost less if you have a larger down payment (and vice versa).
- Your credit score. The higher your credit score, the lower your PMI premium.
- Property appreciation potential. If you live in a market with declining property values, your PMI premium could be higher.
- Type of loan. Adjustable-rate mortgages (ARMs) require higher PMI payments than fixed-rate mortgages.
- Borrower’s occupation. If the financed property is owner-occupied (you will live there), your PMI premium will be lower than a rental or investment property.
Assume you have a 30-4.5% fixed-rate mortgage for $200,000. Your monthly mortgage payment (principal plus interest) would be $1,013. If PMI costs 0.5%, you will pay an extra $1,000 per year, or $83.33 per month, which would bring your monthly house payment to $1,096.70.
In many cases, a single premium PMI is the most affordable option as long as you plan to stay in the house for at least three years. For the same $200,000 loan, you can pay about 1.4% upfront, or $2,800 (compared to about $3,000 after three years with monthly PMI payments).
How to avoid private mortgage insurance
Whichever type you choose, PMI doesn’t come cheap. (And don’t confuse it with mortgage life insurance, which is up to you, or your heirs, to pay your mortgage if you become disabled or die. The lender is the sole beneficiary of PMI.) But ways around it do exist.
An alternative to paying PMI is to use a second mortgage or matching loan. In doing so, the borrower takes out a first mortgage in an amount equal to 80% of the home’s value, which avoids PMI, and then takes out a second mortgage in an amount equal to the sale price of the home minus the down payment and the amount of the first mortgage. For example, with an 80-10-10 piggyback mortgage, 80% of the purchase price is covered by the first mortgage, the second loan covers 10%, and your down payment covers the final 10%. This reduces the loan to value (LTV) of the first mortgage to less than 80%, eliminating the need for PMI. For example, if your new home costs $180,000, your first mortgage would be $144,000, your second mortgage would be $18,000, and your down payment would be $18,000.
Of course, there is a catch: a second mortgage will, in most cases, carry a higher interest rate than the first mortgage.
PMI Strategies
How to choose between these two basic options: use the first mortgage without the support and pay the PMI or use a second mortgage? Several variables can influence this decision, including:
- The Monthly Numbers: Are the Combined First and Second Mortgage Payments Less Than the First Mortgage Payments Plus PMI?
- The tax savings associated with paying PMI correspond to the tax savings associated with paying interest on a second mortgage. Tax law in the United States allows the PMI deduction only for specific income levels, such as families earning less than $100,000. In contrast, there are generally no restrictions on deducting regular mortgage interest.
- The different principal reduction rates of the two options
- The time value of money.
However, the most critical variable in the decision is:
- The expected rate of home price appreciation
For example, if the borrower chooses to use a stand-alone first mortgage and pay PMI versus a second mortgage to eliminate PMI, how quickly can the home appreciate to the point where the LTV is 78%, and the PMI can be removed? This is the predominant deciding factor.
