What Is PMI (Private Mortgage Insurance)?
Point of Interest
For those struggling to put together a 20% down payment on a home, a loan with private mortgage insurance can help close a mortgage deal faster. However, opting for this will cost you more on your monthly payments for a while.
Private mortgage insurance (PMI) is an insurance type that can make it easier for people to buy homes without having a large deposit. Lenders require a 20% down payment conventional loans — but according to the National Association of Realtors, 61% of first-time buyers only had up to 6% for a down payment. The only option to get around a lower down payment is PMI. If a borrower is OK with paying PMI, they can often get a loan with a low down payment.
However, there are some pros and cons to PMI insurance. Before you decide whether or not to take out a loan with PMI, you need to answer the following questions: What is PMI insurance? How does it work? And should I avoid it?
What is private mortgage insurance?
Private mortgage insurance (PMI) is a type of insurance used to offset the risk for lenders granting a mortgage. PMI insurance is typically required when a prospective home buyer does not have the 20% down payment they need to buy a house. With less than a 20% down payment, this increases the risk for lenders. PMI helps to offset that risk and makes the lender more likely to approve a loan.
How much the insurance will cost will depend on the lender you choose. The mortgage lender will arrange the PMI through an insurance provider and let you know the price before you agree to the loan.
Types of PMI
There are several different types of PMI to know about when making a home purchase. These include:
This is a monthly insurance payment that the home buyer must pay in addition to the mortgage payment. You will need to pay this fee until you have paid up to at least 22% equity in your home. Once you’ve reached 22%, your loan servicer is required to remove it.
With LPMI, instead of charging you for the private mortgage insurance, the mortgage lender covers this cost initially. However, to recoup those costs, the lender will charge a higher interest rate on your mortgage. The downside is that you will be paying PMI for the rest of your mortgage, even after you hit 22% equity.
Single premium PMI
This PMI type means that you will need to pay for the entire insurance upfront as a single lump-sum. While this means your monthly mortgage payments may be lower, if you refinance or sell your home shortly after you buy it, you won’t receive a refund on your insurance.
Split premium PMI
Split premium PMI requires a partial upfront payment. This is similar to single premium PMI, but the remaining cost will be paid through the BPMI method.
Cost of PMI
The cost of PMI can vary and is based on several different factors. These factors can include the type of loan, the size of your down payment, the type of PMI chosen, how much insurance the lender requires and your credit score.
PMI costs typically range from 0.5% to 1.5% of the original loan amount each year. However, those percentages can vary outside of that scale. The PMI rate is something you will want to discuss with various lenders before agreeing to a mortgage deal.
How to make PMI payments
Each lender will have a different method of collecting PMI payments. The most common way to pay PMI is to add it to the monthly mortgage payment. An alternative is to make a lump-sum payment each year. However, if you decide to refinance your home or sell it, you will not receive a refund for this.
The other option is a combination of the two. You can choose to make a partial upfront payment and then roll the rest of the costs into your monthly mortgage payment. Each lender will have different terms for this so it is important to do your research and compare lenders on how they handle PMI.
Things to be on the lookout for when choosing PMI
There is a lot of confusion regarding what to consider with PMI. The things to be on the lookout for include:
When it comes to any kind of loan, the best practice is always to shop around for the best deal. Avoid agreeing to a mortgage without doing thorough research on a few different lenders first.
Lump-sum PMI vs. down payment
With some types of PMI, you can pay a lump-sum upfront. However, it could be worth calculating whether it’s best to wait and simply boost your down payment instead.
Canceling the PMI
Avoiding PMI is generally best, but be on the lookout for ways to cancel the PMI if this is the route you’ve taken to secure a home loan. You may want to only focus on lenders offering BPMI, as the PMI will be canceled after reaching 22% equity. Be sure to check the lender’s policy on canceling PMI earlier than that, for example, during house revaluation or refinancing.
How to avoid PMI
While PMI can help you buy a home faster, the additional costs are not ideal. The best way to avoid PMI is to put at least 20% down on your house purchase.
Another way to avoid PMI is to use a government-insured loan. For example, loans back by the U.S. Department of Agriculture and the U.S. Department of Veterans Affairs do not require mortgage insurance.
If all else fails and you take out a loan with PMI, try to cancel it as soon as you can and keep a close eye on your loan balance. Once you reach 20% equity of the home’s original price, ask your lender to cancel the PMI. They aren’t required to cancel it until you reach 22% equity, but some will agree to remove it when you hit 20% equity in your home.
The final word
PMI insurance, while not ideal due to the extra costs, can help you get on the property ladder when you don’t have the money to make a full 20% down payment. This, in turn, can then help to build your wealth and assets sooner.
However, it’s best to avoid it if possible due to the added costs of this type of insurance. If PMI is unavoidable, make sure you choose a PMI plan that allows you to cancel in the future when you hit the right amount of equity in your home.
What is PMI on a mortgage?
PMI insurance is a way for lenders to reduce the risk of approving mortgages for people with less than 20% down payments. This type of insurance is required on conventional loans for buyers who do not have the full down payment to put down on a home. It is required in most cases to be removed when your equity in the home reaches 22%, but until that happens, you will pay for PMI either monthly, upfront or as a combination of the two.
How do I get rid of PMI on my mortgage?
If you have a BPMI plan, you can ask your lender to remove the PMI once you reach 20% to 22% equity in your home. Lenders are required to remove it at 22%, but many will remove it at 20% if you request it.
How can I avoid PMI without 20% down?
You can avoid PMI by opting for a government-insured loan instead, as they do not require mortgage insurance with lower down payments. However, FHA loans, one of the most common government options, does require another type of mortgage insurance, and it can last for the life of the loan, but at minimum, will last 11 years.
Another way is to look for cheaper properties to make your down payment go further. It’s easier to come up with 20% of a $150,000 house than it is 20% of a $500,000 home.
Is PMI good or bad?
Well, it depends on what you want the outcome to be. If you want to buy a home but can’t cobble together the full 20% for a down payment, PMI insurance can help you get on the property ladder sooner, which can be beneficial. However, it does add to your monthly costs — so it is best avoided whenever possible.