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What Is PMI Insurance?

Private mortgage insurance (PMI) is a type of insurance that you must pay if you cannot meet the 20% down payment common to private mortgage loans. PMI insurance reduces the lender's risk because after they front a larger portion of the property's cost. Charging PMI premiums offers the lender some financial recompense if you default on your mortgage payments. Once your principal balance reaches 80% of the original value of your home, you can request for your lender to remove the PMI requirement.

PMI is not always required. Loans in smaller amounts, lenders that offer low down payment loan programs and some types of government-backed loans may not charge for PMI. If you're being charged PMI, keep reading to learn more about how it works.

How PMI Works

You will typically need to pay PMI if you cannot afford a 20% down payment on your home. Lenders charge PMI because they are taking on more risk by approving your loan. You may have enough funds to purchase the property only because the lender is paying a larger portion of the property's value. Charging PMI premiums is one way for a lender to protect their investment in the event a borrower defaults on their mortgage payments.

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. In other words, those who cannot afford the 20% down payment will generally pay for PMI.

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).

You will typically need to pay PMI if you cannot afford a 20% down payment on your home.

Do all lenders require PMI?

Conventional mortgage lenders typically require PMI if you have less than 20% of the down payment, but this is not always the case. Some exceptions include lender-paid insurance (LPMI), which takes the place of PMI and offers low down payments. The tradeoff is paying a higher interest rate, so a lower down payment would still result in high premiums.

Government-backed agencies like Veterans Affairs (VA), Federal Housing Administration (FHA) and the U.S. Dept. of Agriculture (USDA) offer government mortgage loans without mortgage insurance. They often require low to zero down payments and operate under different rules and regulations.

The only exception is FHA loans, which require their own mortgage insurance, known as MIP. MIP is different from PMI and may even offer lower rates. However, unlike private mortgage insurance, borrowers won't be able to cancel the MIP, even after they've gained enough equity.

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. While this translates into an extra cost to your monthly mortgage payment, you might consider the tens of thousands you can gain in home equity that you would otherwise throw away in rent.

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.

PMI can be canceled once you home 20% equity or 78% of the home's value. Equity isn't just tied to the money you've paid towards your mortgage, it is also impacted by the value of your home.

Except for FHA loans, which require MIP insurance, government mortgage loans don't require mortgage insurance.

How Much Does PMI Cost?

Private mortgage insurance rates depend on the type of PMI you apply for:

  • Lender-paid (LPMI)

  • Borrower-paid (BPMI)

With LMPI, 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.

Your PMI costs vary by your loan program and other factors. According to the Urban Institute, PMI generally ranges between 0.58% to 1.86% of the annual loan balance broken down into monthly installments. The more the borrower is considered a risk, the higher their rate for PMI insurance.

The following example pertains to a house valued at $100,000, with a term of 30 years and an interest rate of 4.5%:

Down Payment

5% down

15% down

20% down

Monthly PMI payment

$40

$35

$0

Monthly mortgage payment (principal, interest and PMI)

$629

$575

$507

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How Do You Make a PMI Payment?

You can make a PMI payment through the following schedules:

  • Monthly payments: Many borrowers choose to pay monthly PMI premiums along with their mortgage payments. This increases the size of the bill but allows homeowners to spread out the payments over the year

  • Up-front payments: Some borrowers may pay the total amount in one installment

  • Hybrid payments: Another option is to pay some of the cost up-front and spread the remaining cost into monthly payments

How to Request for Your Lender to Cancel PMI

Buyers can cancel PMI through several methods, including requesting your lender to terminate the requirement, reappraising your home and refinancing.

Once you’ve paid down around 20% of the appraisal value, you can request for the lender to terminate the PMI requirements.

Wait for Automatic Cancellation

Lenders will automatically cancel your PMI once you have around 20% equity or owe only 80% of the home's original value. The principal on your mortgage loan must be $80,000 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 high risk. They may also cancel once it has reached the midpoint of the amortization timeframe — for example, 15 years into a 30-year mortgage loan or halfway through your total loan payments.

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 qualify, you will typically need to meet the following requirements:

  • Solid payment history with no late payments past 30 days in the last year, or 60 days within the previous two years

  • A recent home appraisal of the home's value, as the value can rise and drop

  • Proof of no other debt outside of the mortgage, including lines of credit, home equity loans and second mortgages

Reappraise Your Home

Borrowers can request early PMI cancellation if property values increase in the area. If your home's value has grown and you have made significant home improvements, a new appraisal may be required. Some lenders have specific rules regarding appraisals, so always check with them first.

Refinance

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.

Lender-paid insurance (LPMI) takes the place of PMI and offers low down payments. The tradeoff is  a higher interest rate.

The Difference Between PMI and Homeowners Insurance

As a homeowner, you will likely encounter the terms "mortgage insurance" and "homeowners insurance."

Not all homeowners need mortgage insurance, but most mortgage lenders require home insurance to protect your property.

Mortgage insurance is added coverage that some private lenders require to protect themselves if you default on your loan by being unable to make payments. It does not cover your property or you as the buyer and is an added cost on top of your mortgage payments and home insurance.

Homeowners insurance is coverage for your property. Unlike PMI, it has no bearing on how much down payment you can afford to pay. Instead, it is tied to what it would cost to rebuild your home and replace your possessions.

Private Mortgage Insurance

Homeowners Insurance

Protects the mortgage lender

Protects the homeowner/borrower

Offers some reimbursement if the borrower defaults on their loan payments

Offers coverage if the homeowner suffers losses or damages from a covered event

Required if borrower pays less than 20% down payment

Required by mortgage lender

Monthly, one-time upfront or hybrid payment

Monthly, annually, every 6 months or one-time upfront payment

FAQS

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 (higher interest rates are typically the tradeoff).

Is PMI tax-deductible?

PMI is tax-deductible. When filing taxes, homeowners paying for PMI can treat their payments as mortgage interest. However, if their adjusted gross combined income is over $109,000, or $54,500 if married but filing separately, they cannot deduct mortgage insurance premiums.

Does my credit score impact PMI?

If your credit score is on the lower end of the credit range, you will likely pay a higher PMI premium. A credit score of at least 620 is seen favorably by lenders. Your credit history helps determine your risk factor and whether or not you are likely to default on your mortgage loan.

Can private mortgage insurance help me buy a home?

While it is an additional cost, paying for PMI can help you purchase a home and start building equity. Without PMI, a lender may turn away mortgage applicants who cannot afford at least a 20% down payment on a home. PMI allows people to embark on the path to homeownership earlier instead of waiting before they can make a bigger down payment.

Home Insurance Can Protect Your Investment

While mortgage insurance isn't necessary for all home buyers, homeowners insurance is always required to take out a mortgage loan. Homeownership is a big responsibility, and SmartFinancial can help protect you and your family from theft, fires and more.

Smart Financial can help new or existing homeowners protect themselves and their property at the right price. By filling out our questionnaire, you quickly gain access to home insurance carriers in your area that could match your needs. Enter your zip code below to receive free quotes.

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