Mortgage lenders make many borrowers who don’t have 20% to put down on a home purchase private mortgage insurance (PMI) to protect the lender if the borrower is unable to pay the mortgage. In other words, PMI guarantees your lender will get paid if you are unable to pay your mortgage payments and you default on your loan. For the borrower, it has a benefit, too: Getting private mortgage insurance allows you to purchase a home before you have the full 20 percent of the home’s value saved up for a down payment.
Here’s a primer on what you need to know about private mortgage insurance:
1. What are the different types of PMI?
In general, there are two types of mortgage insurance: mortgage insurance bought from the government, designed for those with FHA loans (this is called mortgage insurance premiums or MIP) or private mortgage insurance for conventional loans which is bought from the private sector (this is called private mortgage insurance or PMI). MIP for FHA and VA loans is run differently and managed internally than private mortgage insurance, and they have their own set of rules.
Basically, the type of mortgage insurance required will depend on the type of mortgage loan you get.
2. Who is required to have PMI?
Typically on a conventional loan, if your down payment is less than 20 percent of the value of the home, lenders
will require you to carry private mortgage insurance. Usually, you pay those mortgage insurance premiums until you have enough equity in your home to have a loan-to-value ratio (LTV) — this is simply the amount of money you borrowed divided by the value of the property you bought — of 80 percent.
For example, let’s say you bought a home with a value of $100,000 and put a down payment
of 10%, or $10,000, and got a $90,000 loan to pay the rest. Your LTV in this case would be $90,000 divided by $100,000, or 90 percent. The longer you pay down your mortgage, the lower your loan-to-value
(LTV) will become. On government loans, mortgage insurance is normally required regardless of the LTV.
3. How much does mortgage insurance cost?
Conventional mortgage insurance rates vary — usually, the lower your down payment and/or the lower your credit score, the higher the premiums. The rate you receive for your private mortgage insurance will depend on your credit score, the amount of money you have for your down payment, and insurer. But typically the premiums for private mortgage insurance can range from $30-70 per month for every $100,000 borrowed. So, if you bought a home with a value of $300,000, you might pay about $150 per month for private mortgage insurance.
On FHA loans
, there is an up-front MIP (mortgage insurance premium) and annual premium which is collected monthly.
4. When do I pay PMI premiums?
When you are required to pay your private mortgage insurance premium depends on your specific loan policy. But typically, paying your mortgage insurance premiums monthly happens right along with your mortgage payment for your current loan (you can just send one payment to the lender). Lenders may also have a policy that allows you to pay your PMI on a lump sum basis either in cash at closing or finance the premium in your loan amount.
5. Why do I need a PMI policy?
Private mortgage insurance minimizes the risk for lenders to offer loans to borrowers who don’t have a 20% down payment and therefore have less equity in their homes once they are purchased. This equity would help pay the loan balance in the event you default and go into foreclosure.
Your lender requires you to have private mortgage insurance so that if you can no longer make payments on your home, the lender will still get paid (through the private insurance policy). PMI basically safeguards the lender in the event of borrower default. It does not protect you, the borrower, if you fall behind on your mortgage payment. If you fall behind on your payments, your credit score could suffer or you could lose your home through foreclosure.
6. How long do I need to have mortgage insurance?
You are typically required to pay a private mortgage insurance premium on a conventional loan for as many months or years it takes to build enough equity in your home to equal 20 percent of your home’s value and have a loan-to-value ratio of 80 percent. For many homeowners with FHA loans, a mortgage insurance premium (MIP) is required for the life of the loan policy, which is up to 30 years. Again, MIP for an FHA loan is different than PMI on a conventional loan. Contact your lender if you have questions about the mortgage insurance premium on your FHA loan.
7. Can I avoid paying for mortgage insurance?
Typically, if you put down 20 percent or more when you buy a home, you can typically avoid paying for private mortgage insurance on a conventional loan (not an FHA loan). Otherwise, there are a few loan options that do not require mortgage insurance:
- In 2016, Bank of America launched a partnership with Self-Help Ventures Fund and Freddie Mac for a new mortgage product called the”Affordable Loan Solution” mortgage. It’s a conforming loan for low- and moderate-income home buyers that allows a down payment of 3% and does not require mortgage insurance.
- Qualified veterans can apply for a VA loan that allows up to 100 percent financing (that’s a $0 down payment) and does not require mortgage insurance. They may only require an upfront funding fee that certain veterans may be exempt from.
- Some credit unions can waive private mortgage insurance on some loans for strong applicants.
- Some lenders offer non-conforming and portfolio options that accept down payments as little as 10-15% and do not require PMI.
- Physician loans typically do not require PMI if the down payment is less than 20%.
Another option to avoid paying PMI, referred to as “piggybacking,” is taking out a smaller loan for enough money to cover the 20% down payment so that you can avoid paying private mortgage insurance. The downside here is that the smaller loan will typically have a higher interest rate than the interest rate on the mortgage loan. But you can typically deduct the interest on our federal tax return. You will also need to consider whether you can afford to pay a second loan for a set number of years in addition to your mortgage payment. Contact your tax adviser or financial planner for more info.
If you are paying PMI on a conventional loan, you can request to cancel it (see below) once you’ve built up enough equity in your home. To stop paying your mortgage insurance policy on an FHA loan, you can refinance to a conventional loan once you have enough equity in your home. You’ll also want to make sure your credit score is high enough to qualify, and that interest rates make financial sense for you. Contact your lender if you have questions about the mortgage insurance on your FHA loan.
8. When does mortgage insurance “fall off” the loan?
Once the borrower has built up a certain amount of equity in the house, typically 20% equity, private mortgage insurance usually may be canceled — which will reduce your mortgage payment and allow you pay less money every month. The lender usually won’t automatically cancel PMI until you’ve reached 22 percent equity based on the original appraised value of the home, or unless you contact them to request cancellation at 20 percent of the current market value. So if you own a home with a value of $100,000 and have paid down $20,000 in principal, you can request to cancel your PMI. Be sure to contact your lender once you’ve hit 20 percent equity.