PMI Insurance: How Down Payment Size Impacts Your Mortgage
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Private mortgage insurance (PMI) is an insurance policy that protects lenders in case the borrower (homebuyer) forecloses on their home because they’ve defaulted on their mortgage payments. It's a common requirement for homebuyers who finance more than 80% of their home's value.
Before you close on your loan, learn how PMI works and what steps you need to take before you can cancel your PMI payments.
What Is PMI?
Private mortgage insurance (PMI) is a type of mortgage insurance typically required when you put less than 20% down when you take out a conventional loan. Your mortgage lender will require PMI as part of your mortgage because they are taking on more risk when they approve a loan where they are financing 80% or more of the property purchase. Charging PMI premiums is one way for a lender to protect their investment in the event a borrower defaults on their mortgage payments.
How Does PMI Work?
The loan-to-value (LTV) ratio helps lenders determine whether or not to enforce PMI premiums as a condition of approving the loan. The LTV ratio is calculated by dividing the mortgage amount by the home's appraised value. To explain, let's use the following example:
- Home appraisal value: $100,000
- Down payment: $10,000
The loan-to-value ratio here is 90% (90,000/100,000). If the LTV is higher than 80%, then you will likely be subject to PMI payments.
Fortunately, PMI requirements will not last your entire mortgage term. Once you've paid down around 20% of the appraisal value, you can request for the lender to terminate the PMI requirements. In the example above, you can make this request once your mortgage principal balance reaches $80,000 (80% of the original property value of $100,000).
Is PMI Required by All Lenders?
Conventional mortgage lenders typically require PMI if you put a down payment of less than 20%, but this is not always the case. Government-backed agencies like the U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) offer single-family housing loans without mortgage insurance. They often require low to zero down payments and operate under different rules and regulations.
How Much Does PMI Cost?
Private mortgage insurance rates depend on whether you’re applying for lender-paid insurance (LPMI) or borrower-paid (BPMI) insurance.
With LPMI, you substitute monthly payments with higher interest rates for the entire life of your loan. BPMI is a monthly fee on top of your mortgage payment that can be terminated once you reach 20% of your home's equity. You cannot cancel LPMI payments.
Your PMI costs vary by your loan program and other factors. According to the Urban Institute, PMI rates generally range from 0.58% to 1.86% of the annual loan balance broken down into monthly installments, with good-credit borrowers usually paying lower rates than poor-credit borrowers.
You can use PMI calculators to estimate your PMI costs and monthly payments. Using the PMI calculator from Freddie Mac, we’ve provided estimated costs for a house valued at $380,000, with a mortgage term of 30 years and an interest rate of 7%:
Monthly PMI Payment
Monthly Mortgage Payment (Principal, Interest and PMI)
What Factors Influence the Cost of PMI?
When applying for a mortgage, your lender will consider several factors to determine your PMI cost. Since PMI is based on the size of your loan balance, increasing your down payment can help lower your monthly payments.
Your credit history also plays a role. A higher credit score, which is usually an indicator of someone who is financially responsible and can make timely payments, can lead to lower PMI premiums. Conversely, a lower score may result in higher charges.
How Do You Make a PMI Payment?
Homeowners can make their PMI payment via a single premium or split-premium. Single-premium PMI involves paying the entire insurance premium upfront in a single lump sum, eliminating the need for ongoing monthly payments. Keep in mind, if you choose this upfront payment method and later decide to move or refinance, you may not be eligible for a refund of this premium.
On the other hand, split-premium PMI offers a blend of the two, where a portion of the insurance cost is paid upfront as a lump sum, and the remaining balance is paid in monthly installments. This allows for some degree of upfront cost reduction while spreading the rest of the payment over time, potentially offering a middle ground in terms of affordability and convenience.
Different lenders may present you with multiple PMI payment options. In some cases, PMI may involve a combination of both upfront and monthly payments. It's advisable to consult with your loan officer to help you understand the total costs associated with each option over various potential timeframes that align with your plans and financial situation.
Are There Advantages To Paying PMI?
The obvious benefit of paying PMI is that it gives homeowners a chance to buy a home without waiting to save up a large amount of money. Consider that 20% down for a home valued at the national median price of $391,800 is $78,360. For some people, saving that kind of money isn’t feasible.
Plus, saving for a down payment could mean missing out if the current housing market is offering low mortgage rates. Instead of waiting, you can move forward right away.
How To Stop Paying Private Mortgage Insurance
Buyers can cancel PMI through several methods, including requesting your lender to terminate the requirement, reappraising your home and refinancing.
Wait for Automatic Cancellation
Lenders will automatically cancel your PMI once you owe 78% of the home's original value. The principal on your mortgage loan must be $78,000 for a home appraised at $100,000, for example.
Making extra payments on your loan principal allows you to build equity sooner. Write a note alongside any additional payments directing extra payments towards the principal balance instead of future payments. Lenders may consider early cancellation when the loan is no longer a high risk. They may also cancel after it has reached the midpoint of the amortization timeframe — for example, after 15 years into a 30-year mortgage loan.
Request To Cancel PMI Sooner
Once you've paid down 20% of the home's appraisal value, you may ask your lender to cancel the PMI. To legally cancel your PMI, fulfill these criteria:
- Submit a written request.
- Maintain a good payment history and make timely payments.
- Certify no junior liens (like a second mortgage) exist on your home.
- Prove that your property value hasn’t dropped below its original value, usually with an appraisal report (otherwise, you may not be able to cancel your PMI payments)
Reappraise Your Home
By reappraising your home, you can potentially remove PMI if the new appraisal shows a significant increase in your home's value, thus increasing your equity. For instance, if you bought a home for $200,000 with a 10% down payment, you initially had 10% equity. If the home's value rises to $300,000, your equity, including your down payment and the value increase, reaches $100,000 or 33.3% of the new value. This is well over the 20% threshold, allowing you to request your lender to move the PMI requirements.
Refinancing could cancel PMI if the new loan amount is less than 80% of the home's value. Plus, borrowers could save money at a lower rate. Refinancing involves fees and paying closing costs, so use a refinance calculator to determine if it's an excellent time to refinance.
How Can I Avoid Paying PMI?
The easiest way to avoid paying PMI is by putting down at least 20% on a home loan. Sometimes called "piggybacking," some buyers take out a second loan to cover the 20% down payment and make two different loan payments. There are also some mortgage loans that do not require PMI or the PMI is actually paid by the lender with higher interest rates typically being the tradeoff (LPMI).