What is private mortgage insurance?
If the concept of buying insurance on your mortgage sounds a little strange, you’re probably a newcomer to purchasing a property or never paid a small down payment. Most lenders require Private Mortgage Insurance PMI when a home buyer makes a down payment of less than 20% of the home’s purchase price, or, in mortgage terms, the loan-to-value (ltv) ratio of the mortgage is higher at 80% (the higher the LTV ratio, the higher the risk profile of the mortgage). And, unlike most types of insurance, the policy protects the lender’s investment in the home, not yours. On the other hand, PMI makes it possible to become homeowners sooner.
PMI allows borrowers to obtain financing if they can only afford (or prefer) to put down just 5% to 19.99% of the cost of the residence, but it comes with additional monthly fees. Borrowers pay their PMI until they have built up enough equity in the home that the lender no longer considers them high risk.
PMI costs can range from 0.25% to 2% (but are typically about 0.5 to 1%) of your loan balance per year, depending on the amount of the down payment and mortgage, the term of the loan, and your credit score. The higher your risk factors, the higher the rate you pay. Also, since the PMI is a percentage of the loan amount, the more you borrow, the more PMI you will pay. There are six large PMI companies in the United States. They charge similar rates, which are adjusted annually.
It’s an added expense, but you continue to spend money on rent and possibly lose market appreciation while hoping to save a larger down payment. There’s no guarantee that you’ll get away with buying a home later than earlier to avoid it, so it’s worth considering the value of paying PMI. The value of paying for Federal Housing Administration mortgage insurance, which you may need if you get an FHA loan, is another story. We will explain it later.
- You’ll need private mortgage insurance (PMI) if you’re buying a home with a down payment of less than 20% of the cost of the house.
- Please note that PMI is intended to protect the lender, not the borrower, against potential loss.
- You can purchase four main types of mortgage insurance: borrower-paid mortgage insurance, single-premium mortgage insurance, lender-paid mortgage insurance, and split-premium mortgage insurance.
- If you get a loan from the federal housing authority to purchase your home, you’ll need an additional type of insurance.
Mortgage insurance coverage
First, you need to understand how PMI works. For example, suppose you pay 10% and take out a loan for the remaining 90% of the property’s value: a down payment of $20,000 and a $180,000. If the lender has to foreclose on his mortgage with mortgage insurance because he loses his job and can’t pay for several months, the lender’s losses will be limited.
The mortgage insurance company covers a certain percentage of the lender’s loss. For our example, let’s say the percentage is 25%. So, if you still owed 85% ($170,000) of the $200,000 purchase price of your home at the time it was foreclosed on, instead of losing the entire $170,000, the lender would only lose 75% of $170,000. 170,000, or $127,500 in home equity. PMI would cover the other 25%, or $42,500. It would also cover 25% of the delinquent interest it had accrued and 25% of the lender’s foreclosure costs.
If PMI protects the lender, why do you, the borrower, pay it? You’re compensating the lender for taking the greater risk of lending to you rather than to someone with a larger down payment, someone who has more to lose if their home goes into foreclosure.
How long have you been paid?
Borrowers can request their monthly mortgage insurance payments waived once the loan-to-value ratio falls below 80%. Once the mortgage’s ltv index drops to 78%, meaning your down payment, plus the loan principal you’ve paid, equals 22% of the home’s purchase price, the lender must automatically write off the PMI as required by federal homeowners protection law, even if your home’s market value has gone down (as long as you’re current on your mortgage).
Otherwise, how long you have to take PMI depends on the type of PMI you choose.
Mortgage insurance paid by the borrower
The most common type of PMI is Borrower Paid Mortgage Insurance (BPMI). When you read about PMI, and the class is not specified, this is usually the type being discussed.
Bpm comes in the form of an additional monthly fee that you pay with your mortgage payment. After your loan closes, you pay BPMI every month until you have 22% equity in your home based on the original purchase price. At that point, the lender should automatically cancel BPMI as long as you are current on your mortgage payments. Accumulating enough home equity through regular monthly mortgage payments to pay off the BPMI typically takes about 11 years.
You can also be proactive and ask the lender to pay off BPMI when you have 20% equity in your home. Your mortgage payments must be current. You must have a satisfactory payment history. There must be no additional liens on your property. And in some cases, you may need a recent appraisal to substantiate the value of your home and show that you had not diminished below the deal when you bought it.
Some loan servicers will allow (but are not required to qualify) borrowers to pay off their PMI earlier based on home value appreciation. Suppose the borrower accumulates 25% of the principal due to preference in years two through five, or 20% after year five. In that case, the investor who bought the loan (most mortgages are sold to investors) can allow PMI write-off after a home value increase is derived from an appraisal. Broker price opinion (bpo), or automated valuation model (AVM, which considers the value of similar properties recently sold).
You may also be able to get rid of PMI early by refinancing, though you’ll have to weigh the cost of refinancing against the costs of continuing to pay mortgage insurance premiums. You can also get rid of it early by prepaying the principal on your mortgage, so you have at least 20% equity.
You must decide if you are willing to pay PMI for up to 11 years to buy now. Look beyond the monthly payment. How much will PMI cost you in the long run? What will it cost you to wait to buy? Yes, you lose the accumulation of home equity while you’re renting, but you also avoid all the disposable costs of homeownership, like homeowner’s insurance, property taxes, maintenance, and repairs. And the Tax Cuts and Jobs Act of 2017, which doubled the standard deduction, made the mortgage interest tax deduction no longer as valuable as it once was.
The remaining three types of PMI are not as expected. However, you may still want to know how they work if one seems more appealing or your lender presents you with more than one mortgage insurance option.
Single premium mortgage insurance
With single-premium mortgage insurance (SPMI), also called lump-sum mortgage insurance, you pay for mortgage insurance upfront in a lump sum. Either in full at closing or mortgage-financed (in the latter case, you can be called single mortgage insurance).
The benefit of SPMI is that your monthly payment will be lower compared to BPMI. This can help you qualify to borrow more to buy your home. Another advantage is that you don’t have to worry about refinancing to get out of IMP or look at your loan-to-value ratio to see when you can pay off your IMP.
The risk is that if you refinance or sell in a few years, none of the one-time premia is refundable. Also, if you finance the single premium, you’ll pay interest on it for as long as you have the mortgage. Also, if you don’t have enough money for a 20% down payment, you may not have the cash to pay a premium upfront. However, the seller or, in the case of a new home, the builder may pay for the borrower’s single-premium mortgage insurance. You can always try to negotiate that as part of your purchase offer.
Single-premium mortgage insurance can save you money if you plan to stay in the home for three years or more. Ask your loan officer if this is the case. And keep in mind that not all lenders offer single-premium mortgage insurance.
Mortgage insurance paid by the lender
With lender-paid mortgage insurance (LPMI), your lender will technically pay the mortgage insurance premium. in fact, you’ll pay it back over the life of the loan in the form of a slightly higher interest rate. Unlike bpm, you cannot cancel PMI when your principal reaches 78% because it is embedded in the loan. Refinancing will be the only way to lower your monthly payment. Your interest rate will not decrease once you have 20% or 22% equity. PMI paid by the lender is non-refundable.
The benefit of lender-paid IMP, despite the higher interest rate, is that your monthly payment may still be lower compared to the monthly IMP payments, and you may qualify for more loans.
Split Premium Mortgage Insurance
Split-premium mortgage insurance is the least common type. It is a hybrid of the first two types we discussed: bpmi and spmi.
Here’s how it works: You pay part of the mortgage insurance as a lump sum at closing and amount monthly. You don’t have to get as much extra cash upfront as you would with SPMI, nor does it increase your monthly payment as much as you would with BPMI. One reason to choose split-premium mortgage insurance is a high debt-to-income ratio. When that’s the case, raising your BPMI monthly payment too much would mean you won’t qualify to borrow enough to buy the home you want.
The initial premium can vary from 0.50% to 1.25% of the loan amount. The monthly premium will be based on the loan-to-equity ratio before considering any financed premium.
As with SPMI, you can ask the builder or seller, or even the lender, to pay the initial premium, or you can transfer it to your mortgage. Split premiums may be partially refundable once mortgage insurance is terminated or canceled.
Federal mortgage protection for home loans – mip
There is also a fifth type of mortgage insurance used with loans underwritten by the Federal Housing Administration, better known as an FHA loan or mortgage. FHA insurance is known as MIP and is a requirement for FHA loans, and down payments of 10% or less cannot be eliminated without refinancing the home. MIP requires an upfront payment, and monthly premiums are usually added to the monthly mortgage note. The buyer still has to wait 11 years before withdrawing the MIP from the loan if they had a down payment of more than 10%.