PMI – Private Mortgage Insurance, Explained

Private Mortgage Insurance

What is PMI ?

PRIVATE MORTGAGE INSURANCE 

Private mortgage insurance, abbreviated as PMI, is a type of insurance that lenders require for borrowers whose home loan is more than 80% of the home’s purchase price. This means homebuyers who put less than 20% of the total value of a property are required to obtain PMI. 

Borrowers with less than 20% riskier than other borrowers in the eyes of a lender. PMI is designed to protect lenders should the borrower default on their monthly mortgage payments. Alternatively, PMI offers potential homeowners the opportunity to own a home with less than 20% for the down payment. 

Let’s be clear, private mortgage insurance is not optional for borrowers who put less than 20% down payment. However, there are alternatives to PMI which are discussed at the bottom of this page. 

Typically, PMI costs range from 0.5% to around 1% of the entire loan amount annually. Usually it is paid every month as part of the overall mortgage payment to the lender in addition to the mortgage principal, interest, and other fees. The cost of private mortgage insurance is determined by the amount of down payment, the borrower’s financial background, and the size and amount of mortgage. 

The borrower will stop paying PMI when the home accrues equity of 20% or when the principal balance on the mortgage reaches 78% LTV( loan-to-value). 

Down payment, Private Mortgage Insurance, PMI
Photo courtesy of Consumer Finance Protection Bureau

WAYS TO PAY YOUR PMI

Though PMI payment options differ by lenders, these are the common ways to pay for PMI.

  1. Monthly premiums – You can make monthly payments and reach the point that you owe 80% or less. 
  2. Single-premium mortgage insurance – You can also pay your PMI by making one lump-sum payment upfront. 
  3. You can pay your PMI by paying some amount upfront and the remaining amount in your monthly premiums. 
  4. Lender-paid mortgage insurance –This option entails a lender paying your PMI and passing on the cost to you at a higher interest rate. 

WHEN CAN I CANCEL PMI?

Canceling PMI can be a hassle! However, it’s possible to cancel your PMI when you’ve reduced your mortgage to less than or equal 78% of LTV. The Consumer Finance Protection Bureau has provided the steps to requesting a removal of PMI from your mortgage. Below you will read ways to help you reach 78% of LTV or less.

One option is to overpay on your monthly mortgage payments. This will reduce your loan amount and put you in a position to cancel PMI one you reach 78% LTV. Not my first choice.

Instead you should consider home price appreciation at the time of purchase. If your home is appreciating in value at a rapid pace, then you could easily reach 78% LTV in no time. On the other hand if you buy in an area that is depreciating, then it will be tough to cancel your PMI. Home price appreciation is key to canceling PMI.

PMI, Private mortgage insurnace
Example of PMI for Home value = $200,000

HOW TO AVOID PMI

If you want to avoid paying PMI, then there are a few things that you can do. The first and most preferable way is to bring a 20% down payment. A 20% or more as a down payment will remove the bank’s PMI requirement. This is the method that is most recommended.

In the event that you don’t have 20% or more as a down payment then you will need to go another route. Another way to avoid paying PMI altogether is to get a piggyback mortgage. A piggyback mortgage is also referred to as a 2nd mortgage or Home equity loan. The loan is written at the time of your 1st mortgage and will cover up to 100%.

For example, say you’re buying a $200k home. A 20% down payment is $40K. If you do not have $40k, then you can avoid PMI by taking out a 2nd mortgage. It will still need to be paid back monthly, but at least sometimes the 2nd mortgage is written with the same bank as the 1st. The 2nd mortgage can be a hassle because it will require you to make 2 monthly mortgage payments. Who wants to do that?

Key Takeaways for PMI

PMI payments are expensive. Save as much as you can for a down payment so that you can avoid PMI altogether. If you do need to pay PMI, then buy in an area where home prices are appreciating and will continue to appreciate in the future. Check out our Buyer’s Blog for more great content.

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