Home New loan Private Mortgage Insurance: How PMI Works

Private Mortgage Insurance: How PMI Works

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If you do a advance payment less than 20% on your home, you will likely need to purchase private mortgage insurance, or PMI. When you put down a small down payment, lenders tend to think of you as a high risk candidate for a mortgageand the PMI requirement protects your lender if you default on your loan.

Although the PMI allows potential homeowners, especially first-time buyers, to qualify for a mortgage with less than 20% down, the monthly premium will add hundreds of dollars to your mortgage payment each month – so be sure to take these expenses into account when determining your home buying budget. PMI is required for conventional loans and Federal Housing Association loans, but some types of loanAs AV loansdon’t need it.

Here’s everything you need to know about PMI, how it works, when you need it, and how much it’ll cost you over the life of your mortgage.

What is PMI and how does it work?

PMI offers buyers the option of buying a home using a conventional mortgage with less than the required 20% down payment. PMI protects lenders who offer financing options with a lower down payment. If you are unable to afford a 20% down payment, lenders view you as a riskier borrower with a greater likelihood of defaulting on your mortgage. If this were to happen, the lender could use the escrowed PMI payments you paid up until the default to recover some of their loss.

The cost of ART

Borrowers with PMI typically pay between 0.5% and 1.5% of the loan amount on average each year — or between $30 and $70 per month for $100,000 borrowed, according to Freddie Mac. For example, if you take out a $250,000 loan with a 5% down payment, PMI would add between $1,188 and $3,563 per year, or about $100 to $300 added to your monthly mortgage payment.

How you pay PMI, whether monthly or annually, varies by lender. Some may also allow you to make a partial upfront payment at closing, which may reduce your monthly or annual PMI payments.

How to lock in a low PMI rate

  • Credit score: The more your credit scorethe more likely you are to lock in a lower mortgage interest rate and PMI premium.
  • Advance payment: The closer you get to a 20% down payment, the lower your PMI rate will be and the sooner you can get rid of it.
  • Occupation: Owner-occupied properties get lower PMI rates than rental or investment properties.

When can I stop paying PMI?

PMI is generally no longer necessary once you have at least 20% of the equity in your home, either by paying down the principal or increasing the value of your home. In fact, your lender is required to cancel your PMI once your mortgage balance reaches 78% of the original purchase price of your home.

However, some lenders may have other requirements that you must meet before meeting your PMI obligations. It could be making a certain number of mortgage payments, getting a new appraisal, or owing less than 80% of your loan principal.

Although this process may differ slightly from lender to lender, you can usually request Cancellation PMI in writing once you have reached the 80% loan-to-value threshold. You must meet specific requirements as set forth by the Consumer Financial Protection Bureau, including:

  • A good payment history
  • Current loan status (not in default)
  • Own funds must not be the subject of a subordinated loan
  • Proof of value, if requested (obtained through an appraisal)

Borrowers with Fannie Mae or Freddie Mac mortgages have a different threshold for withdrawing PMI if the mortgage is between two and five years old. For these borrowers, equity must be at least 25% before the PMI can be terminated.

The advantages of the PMI

Although PMI adds an extra expense to your monthly mortgage payments, in some cases it may be worth it. Here are some benefits of PMI:

  • You can buy a house earlier: For many potential homeowners, high down payment requirements make owning a home unfeasible. With down payment requirements as low as 3%, borrowers can buy a home sooner.
  • You are able to create wealth sooner: Owning a home can help increase your net worth. Buying a home sooner with the help of the PMI can also help you build capital faster, which in turn could help you eliminate the PMI sooner.
  • This is only a temporary cost: Once you have reached an LTV ratio of 80% (75% for Fannie Mae and Freddie Mac loans), you can request the removal of the PMI. If you don’t ask, lenders are required to automatically remove the PMI when you reach 78% LTV.
  • The PMI is currently tax deductible: If you file an itemized tax return, you can currently deduct private mortgage insurance from your tax return until the end of 2021. This tax relief was reinstated in the Supplementary Consolidated Credits Act 2020 and extended to in 2021 in the consolidated credit law in January 2021. .

Disadvantages of PMI

While PMI can help you get a mortgage with a lower down payment, there are some downsides to consider.

  • It’s an added bonus: No matter how low your PMI interest rate is, you will always pay an additional expense each month.
  • PMI rates can be high: PMI rates are based on your credit score, home occupancy, down payment amount and net worth appreciation. A high PMI rate could increase your monthly mortgage payment by more than you can comfortably afford.
  • Canceling PMI takes time: You are still required to pay the PMI until the lender cancels it at 78% LTV. When requesting cancellation earlier, you will often need to make a formal request in writing, which can take time to process and clear. You may also have to pay for an appraisal if your lender requires one.

Do all home loans require a PMI?

Although the PMI is generally only required for conventional mortgages, other types of specialty mortgages have their own version of it, with their own requirements.

  • Conventional mortgages: If you put less than 20% on a conventional loan, expect to pay PMI. There are some non-PMI options, but these usually include higher interest rates, which could actually cost you more in the long run.
  • FHA Loans: FHA Loans allow you to borrow with as little as 3.5% down payment and have a monthly insurance premium or MIP. Depending on your lender, your MIP may require an upfront payment at closing and monthly or annual payments thereafter. Borrowers who downpay 10% or more must pay MIP for 11 years, while borrowers who downpay less than 10% must pay PMI for the life of the loan.
  • USDA Loans: Although USDA Loans do not require a down payment, there is a mortgage insurance requirement, with initial and annual fees attched. An initial fee of 1% of the loan value is due at closing and an annual fee of 0.35% is due annually. Although USDA mortgage insurance cannot be waived, it is generally more affordable than FHA MIP and interest rates tend to be lower.
  • VA Loans: There are no mortgage insurance requirements for VA loans, but borrowers will pay a one-time origination fee of between 1.4 and 3.6 percent, depending on the amount of the down payment. These fees can usually be rolled into the loan amount.
  • ARM loans: an MRA, or adjustable rate mortgage, may also include PMI. The initial cost may be higher, but you may be able to build equity more quickly, allowing you to remove PMI faster than with a fixed rate mortgage.

Is the PMI worth the expense?

There is a compromise here. PMI increases your monthly mortgage payment, but may allow you to buy a home with a lower down payment. That said, you may be able to waive PMI if you get another type of loan, such as a conventional USDA, VA, or non-PMI loan, or if you’re saving for a larger down payment. If you decide to go the PMI route, compare private mortgage insurance rates from various lenders before committing.