The 4 Types of PMI and Considerations for Each
Point of Interest
While it’s never exciting to find out you have to pay an additional fee, PMI helps many prospective homebuyers qualify for a loan on a home without a full 20% down. Thanks to PMI, buyers can close on a home loan with as little as 3% down, but in return will have to pay for private mortgage insurance to protect the lender for taking the additional risk. In the eyes of many, that’s a fair deal.
When purchasing a home, 20% is often quoted as the standard down payment. In reality, though, statistics show this is no longer the standard. According to the 2019 National Association of Realtors report, the median percentage financed on a home is 87%, meaning a median down payment of about 13%. That begs the question of why 20% is still referenced as the standard down payment amount. The answer is that 20% is the required equity you need in your home — through payments or down payment — to avoid paying private mortgage insurance, or PMI.
What is private mortgage insurance, or PMI?
When you take out a loan to purchase a house, your lender inevitably has concerns about whether or not you’re going to be able to pay that loan back. Quantifying when those concerns are valid is done by looking at your creditworthiness and the down payment you put on the home.
When your creditworthiness is low, the lender may choose to deny you the loan or give you a less-than-stellar interest rate. The other factor they look at is the size of the down payment you make to the price of the house. If a buyer can put down at least 20% of the price of the home, lenders are much more comfortable with the safety of the loan, as this demonstrates your ability to save and shows your financial liquidity.
When you are not able to put down 20% or more as a down payment on a house, lenders look for a way to mitigate the added risk. This is done through private mortgage insurance, or PMI. PMI is a form of insurance that protects the lender in case the borrower defaults on the loan and the home goes into foreclosure.
It’s a common misconception that PMI protects the homeowner, when, in fact, it is designed to protect the lender. The benefit to the homeowner, though, is that it allows many people to purchase a home before they’re able to save up a sizable down payment.
The four types of PMI
Not all forms of private mortgage insurance are created equally. There are four different types of PMI associated with making a home purchase.
1. Borrower-paid (BPMI)
The most common form of PMI is borrower-paid PMI (BPMI). BPMI is a monthly fee you pay every month in addition to your mortgage payment. You will continue to pay for this insurance until you have built 22% equity of the home’s current value or the purchase price of the home, whichever is less (in your favor).
Borrowers can request BPMI be removed when they have 20% equity built up, but there are no guarantees the lender will oblige. Once the equity reaches 22%, though, BPMI must be removed.
The main advantages of BPMI are that there are no upfront costs and that it can be canceled at any point in time when you reach the correct equity benchmark. You can get BPMI removed early through refinancing or if your house has appreciated enough in value. Lenders will require an appraisal in the latter situation, and you may be responsible for paying for that appraisal. A refinance can be attractive, but remember, you will have to pay fees and closing costs on the new loan.
2. Lender-paid (LPMI)
The second available form of private mortgage insurance is lender-paid PMI (LPMI). While this may sound like a win for the borrower, the costs are still shifted back to you even though the lender is paying the PMI. Your lender will roll the cost of the PMI into your payments via raising your interest rate.
Yes, this could spell lower monthly payments, but you’ll be paying for the PMI for the entirety of the loan. When you reach the 20% to 22% equity threshold where BPMI would come off, your interest rate is not lowered.
3. Single premium PMI
With single premium PMI, you pay your insurance premiums upfront as a single lump-sum payment or as a lump sum that is financed throughout the life of your loan. There are several pros and cons here. Your payments will be lower with either single premium PMI option. You’ll also not need worry about getting the PMI canceled, as you’ve already paid for all of it upfront.
The drawbacks to this form of PMI come if you refinance or sell your home quickly. You prepaid for the insurance but you won’t be getting a refund if you don’t need that much coverage. Additionally, this form of PMI does require a larger chunk of upfront cash that you may not have after covering the down payment and closing costs. Single premium PMI is also not available through every lender.
4. Split premium PMI
Split premium PMI is the least popular of the four options, but may provide savings to some. With this option, borrowers pay a portion of the PMI upfront, like with the single premium option. The remaining amount is paid as BPMI. The benefit? You’ll save with lower payments as you’d paid a chunk of the insurance upfront.
Cost of PMI
The cost of PMI will vary based on several factors, including the type of plan you choose, the type of loan, the size of your down payment, your creditworthiness, the amount of insurance required by the lender and any additional risk factors the lender deems important. PMI costs start at 0.25% and can go up as high as 5% or 6%, though the average rates many will see fall between 0.5% and 1.5%. These are annual percentages based on the amount of the loan.