What is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance (PMI) serves as a safeguard for a lender when a borrower makes a down payment of less than 20% on a home purchase, according to the Insurance Information Institute (III). It's designed to reduce the risk associated with smaller down payments on homes, while giving people an option to purchase a home with less equity.
For example, if you’re buying a home for $300,000 you would likely need to make a down payment of around $60,000 (20% of your total purchase price) to avoid paying for PMI.
When is PMI required?
Lenders typically require PMI when the down payment on a home is less than 20% of the property's value.
How does PMI work?
PMI acts as a guarantee that, if a borrower defaults on a mortgage, the insurer will pay the mortgage lender for any losses they incur in a foreclosure up to a predetermined amount. Lenders generally require PMI when the down payment is less than 20% of the purchase price, but they may also require it due to economic considerations, says to the III.
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get a quoteTypes of PMI
Understanding the nuances of PMI involves exploring the different types, each tailored to different borrower and lender needs. These distinct categories delineate how PMI is structured and paid for, but all are different approaches lenders may take to mitigate their risk. Here are the five main types of PMI, according to Investopedia:
- Borrower-paid mortgage insurance: Borrowers pay the premiums directly to the insurer.
- Single-premium mortgage insurance: Borrowers pay a one-time premium at closing.
- Lender-paid mortgage insurance: Lender covers the cost of PMI in exchange for a higher interest rate.
- Split-premium mortgage insurance: Combines elements of borrower-paid and lender-paid options.
- Federal home mortgage protection (MIP): Used only with Federal Housing Administration (FHA) loans and are required for down payments of 10% or less. These cannot be removed without refinancing the home.
How much does PMI cost?
PMI costs can vary based on several factors. The Consumer Financial Protection Bureau (CFPB) mentions the following points that can affect PMI cost:
- Type of loan: Depending on what kind of loan you get, this can significantly impact the cost of PMI.
- Down payment: Higher down payments can reduce PMI costs.
- Credit score: Better credit scores often lead to lower PMI rates.
- Loan-to-value (LTV) ratio: The lower your loan amount is in comparison to the total value of your home plus closing costs minus your down payment, can decrease the cost of PMI.
- Interest rates: Fluctuations in interest rates can influence PMI costs, as well as if you have a fixed or adjustable rate.
How can you avoid PMI?
The most straightforward way to avoid getting PMI is to make a down payment that meets the lender’s requirements to forego it. Alternatively, some government-backed loans do not require mortgage insurance, provided that you qualify. Lender-paid mortgage insurance can also be a viable alternative for some borrowers according to Investopedia; you may have a higher interest rate but your monthly payments could be lower than making monthly PMI payments.
Benefits of PMI
The biggest benefit of PMI is that it provides people who can’t make a 20% down payment with a chance to own a home. PMI also helps the housing market, according to Travis Credit Union, because it allows more potential buyers into the market.
Private mortgage insurance vs. homeowners insurance
Private mortgage insurance is designed to protect the lender in case the borrower defaults, whereas homeowners insurance safeguards the homeowner by insuring the property and its contents against damages and liabilities. The two are completely different types of insurance. As mentioned before, PMI may be required depending on your down payment amount. You’ll need homeowners insurance if you’re financing your home, regardless of whether or not you have PMI. Homeowners insurance is recommended even after your mortgage is paid off.
Can you cancel PMI?
Yes, borrowers can typically make a request to cancel PMI once they reach at least 20% equity in their home, either through appreciation, payments or a combination of both. Be sure to discuss these options with your lender to see what makes the most sense for your specific financial situation.