Private mortgage insurance explained
by Shawn Carvin, Senior Mortgage Banker
Private mortgage insurance (PMI) is a risk-management tool that protects the lender against loss if the borrower defaults. Borrowers subject to private mortgage insurance pay the insurance premiums – which are included in their mortgage payments – on a monthly basis until they’ve accumulated enough equity in the house to make mortgage insurance unnecessary.
When does a home buyer need PMI?
Almost all lenders will require private mortgage insurance (PMI) for a conventional mortgage that has a loan-to-value (LTV) over 80%, meaning that the borrower owes the lender a sum which is greater than 80% of the market value of the home. This scenario is common when the borrower’s down payment is less than 20% of the purchase price.
Obtaining PMI allows a borrower to make a smaller down payment, permitting them to purchase a home without the need for substantial savings, a gift from family members, or dipping into retirement funds.
When is PMI not required?
Home buyers utilizing FHA loans do not require traditional PMI. However, a different type of mortgage insurance is required with FHA loans. A 1.75% upfront premium can be financed into the loan, and an annual insurance premium is baked into the monthly mortgage payments for the full term of the loan.
Similarly, VA mortgages do not require PMI but an up-front funding fee is assessed, which serves a similar purpose. This fee can be financed into the loan, or even waived for veterans (and their surviving spouses) receiving service-connected disability benefits. Otherwise, VA loans do not have any additional monthly or annual fees associated with mortgage insurance.
How much does PMI cost?
Private mortgage insurance costs about 0.2% – 2% of the loan balance annually, depending upon the borrower’s down payment, credit score, and the term of the loan. The higher the risk factors, the greater the rate.
How and when to get rid of private mortgage insurance
If you have PMI, the mortgage lender is supposed to automatically terminate the policy on the date when the outstanding principal on the loan is scheduled to become 78% of the original purchase value of the home. This date is determined by the amortization schedule of your loan, and this information will be provided to you in writing by the lender at the closing table. This holds true even if the market value of your home has declined, and the principal value is actually higher than 78% of the current value.
You can also make a written request to the lender to cancel PMI at any time the principal balance becomes less than 80% of the original value, such as if you have made extra payments to reduce the loan balance.