Buying a house is quite possibly the largest investment that most people will ever make. And when you consider that the median price of a new home in the US has been around $320,000 since 2018, the thought of actually hitting that milestone may seem out of reach for some.
It can also be one of the most confusing, especially for first-timers. Homebuyers attempt to master a whole slew of new vocabulary terms, from “contingencies” to “escrow” to “fixed versus adjustable rate mortgages.” Another one of the mystifying terms is PMI.
What is PMI?
PMI stands for “private mortgage insurance.” When you hear “insurance,” you may think it’s there to protect you in case something goes wrong with your home loan.
Actually, PMI is there to protect the lender that’s likely offering you a conventional mortgage, whether it be a refinance or a purchase loan. In other words, PMI is mortgage insurance for the lender, not for you.
If you are qualified for a home loan and are putting less than 20% down, you may be required to pay for PMI.
PMI is insurance on your mortgage that the lender requires you to purchase in order to protect them if you default on the loan.
It will help them recoup their losses if, for some reason, you can’t make your mortgage payments and go into default on the home loan.
When a lender is considering whether to extend a mortgage loan, and on what terms, they look at something called the loan-to-value ratio, or LTV. This is equal to the mortgage balance divided by the value of the property.
The more money you have for a down payment, the less you need to take out a loan for, and therefore the lower your LTV ratio. Whether you’re buying a home or refinancing, the higher your LTV ratio, the more of a gamble you’re likely to appear to lenders.
And they’ll usually want you to have PMI when your LTV is less than 80%, which is what happens when you put less than 20% down.
Don’t confuse this with homeowner’s insurance, which covers your home and belongings in the event of an emergency or accident, or mortgage protection insurance which helps pay for your mortgage in the event of a job loss or death.
Private mortgage insurance is usually required when there is less than a 20% down payment. These loans present a slightly higher risk to the lender – who wants to insure their investment. In general, if you put down less than 20% on your mortgage, then you will likely have to pay PMI on your mortgage.
The upside of mortgage insurance is that paying insurance on your loan can make you eligible for a loan you might not otherwise qualify for, and can allow you to purchase a home even if you don’t have a 20% down payment.
Private mortgage insurance has been around for more than 60 years . Over that time period, more than 30 million families, including 1 million in 2018, relied on PMI in order to buy or refinance a mortgage. A significant amount of those who did were low-income or buying their first homes.
How Much Does Private Mortgage Insurance Cost?
How much your private mortgage insurance costs depends on the type of mortgage you get, how much your down payment is, your credit score, type of property, type of transaction, and the level of PMI coverage required by your lender. The cost of your PMI is often included in your monthly payments.
If you’d prefer it weren’t part of your monthly payments, you could also pay an upfront premium when closing on your home. This means that you could buy out your mortgage insurance for the life of the loan by paying the full premium upfront as part of the closing costs. You may also choose a combination of both upfront and monthly payments.
PMI generally costs between 0.58%-1.86% of the mortgage amount annually, but premium costs can vary depending upon the loan scenario.
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How to Pay PMI
There are a few different options for paying PMI, which depend on your preferences. Many borrowers pay PMI as a monthly premium that is added on to the mortgage payment. You can see what the premium is in both the loan estimate you get when you apply for the mortgage and again in your closing disclosure.
The PMI factor can change between these two estimates because the appraisal valuation which drives the final LTV (loan to value) may be received by the lender after the Loan Estimate is generated.
Another option is to pay your PMI all at once in a single sum when you close on the house. Or you can ask the lender if they can cover some or all of the PMI cost through lender rebate money.
Generally, in this scenario a borrower accepts a higher rate and the rebate money in that higher rate comes back to the borrower as a credit and the borrower can use that lender credit to cover some or all of the PMI cost.
Ask a lender to generate a quote with different PMI payment options so you can compare and choose the best plan for your budget.
Keep in mind that some PMI policies are refundable and some are non-refundable. A third scenario is to pay some of the PMI up front and get the rest added on to your mortgage payment each month.
If you’re confused about the different policies and payment options, ask the lender’s representative to explain the options to you and ask for a quote on how much you will owe in different scenarios.
If you are purchasing a home, you may be receiving a seller credit towards your closing costs, and this can be another way to cover the PMI in one lump sum and not have ongoing monthly payments.
How to Get Rid of PMI
For a principal residence or second home, the borrower can initiate cancellation of PMI under the following scenario: The LTV ratio must be:
• 75% or less, if the seasoning of the mortgage loan is between two and five years.
• 80% or less, if the seasoning of the mortgage loan is greater than five years.
The “seasoning” of a mortgage loan is the number of years the borrower has made payments and is considered as being in good standing. If Fannie Mae’s minimum two-year seasoning requirement is waived because the property improvements made by the borrower increased the property value, the LTV ratio must be 80% or less.
For automatic termination of PMI the guidelines are:
• A single-family, principal residence or second home that is security for a mortgage loan closed on or after July 29, 1999.
• The borrower is current on their mortgage payments as of the applicable PMI termination date.
The applicable termination date is:
• the date the principal balance of the mortgage loan reaches 78% of the LTV ratio, or
• the first day of the month following the midpoint of the mortgage loan amortization period, if the scheduled LTV ratio for the mortgage loan does not reach 78% before then.
Your lender is required to tell you how long it’ll take to pay down your mortgage enough to qualify for PMI cancellation. You will see this information in your loan packet as a disclosure. They also must give you information every year about how to cancel your PMI.
When PMI Is not Required
Borrowers will generally need to have more than 20% equity in their home to not be required to have PMI.
The Homeowners Protection Act was put into place to protect consumers from paying more PMI than they are required to. Specifically for residential mortgages closed on or after July 29, 1999, the Act covers two scenarios: automatic PMI termination and borrower-initiated termination.
Automatic PMI termination is effective when the principal balance of the loan reaches 78% of the LTV ratio of the original property value. If that percentage of LTV ratio is not reached by the midpoint of the mortgage amortization period, the PMI is automatically terminated at that midpoint.
The borrower can initiate cancellation of PMI when the balance of the mortgage loan reaches 80% of the LTV ratio of the original property value. By keeping track of when this percentage will be reached, the borrower may be able to save some money.
If the current value of your home has increased through market appreciation and/or qualified home improvements, then you may have more equity in the property and owe less than 80% of it’s worth, which could qualify you to cancel PMI on your mortgage earlier than anticipated.
The original value of a home is determined by the original appraised value or purchase price of the home, whichever is less.
You will need to work with your lender to see if you are eligible and what is required to approve your request.
Or you could refinance your home loan, effectively creating a new mortgage in which you have a greater share of equity.
One caveat is that FHA loans, which have their own benefits, carry with them a government mortgage insurance called Mortgage Insurance Premium (MIP), which in most cases is applied for the life of the loan. The only way to cancel it is to refinance your FHA loan into a conventional loan without PMI or MIP.
Additionally, military personnel who are eligible to apply for a VA loan do not get charged PMI. VA loans never charge private or government mortgage insurance even for borrowers who don’t put 20% down.
Another potential option to avoid PMI is to utilize an 80/10/10 mortgage. These mortgages (or piggyback loans) are generally used by homeowners who don’t have 20% to put down on their down payment.
You’ll take out two loans at the same time, one for 80% of a home’s value, and the other to cover the amount you don’t have to get up to 20% down after your down payment is applied (usually 10%). Piggyback loans are also called a second trust deed loan.
One last option you have to avoid PMI is the Lender-Paid Mortgage Insurance (LPMI) option. With this option, your lender will cover the cost of the PMI, likely in exchange for a higher interest rate on your mortgage loan.
As you can see, there are many different options you have if you don’t want to be required to pay PMI. The easiest is to put 20% down on your loan, but if you are unable to do so there are a few workarounds. Now that you are familiar in the world of PMI, you can continue your search for mortgage loans.
While you are researching it is worth checking out SoFi. With SoFi, you can make your dream home a reality with competitive rates, no hidden fees, and as little as 10% down.
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