You can get a conventional mortgage through a bank, credit union or mortgage company to buy or refinance with less than 20 percent equity. Considered a high-risk loan, the lender usually requires you to pay for private mortgage insurance, or PMI, which covers the lender in case you default. You commit to paying a PMI premium for at least a couple of years before your lender agrees to cancel it; however, you may have a choice of payment methods.
The most common way to pay the PMI premium is in monthly installments. Your lender bills you for 1/12 of the premium amount and you remit payment along with your mortgage payment. The lender, which chooses the PMI provider, collects the payments and pays the premium annually on your behalf. To determine the annual premium and monthly installment, you need to know the PMI rate on your loan, which typically ranges from .3 percent to 1.15 percent. Divide your PMI rate by 100 and multiply that figure by your loan balance to get the annual premium. Then divide the premium by 12 for installment amounts. For example, a $200,000 loan with a PMI rate of .75 yields a premium of $1,500 and installments of $125. (.75 x 100 = .0075) (200,000 x .0075 = 1,500) (1,500/12 = 125).
Single Premium PMI
A conventional lender may give you the option of paying off your PMI premiums in advance. By paying a lump sum at closing, you avoid paying monthly installments in addition to your mortgage payment, but your lender is still covered. Known as a single-premium PMI, you can finance the lump sum into your new loan or you can pay for it at closing, on top of the rest of your settlement fees. The single premium PMI usually equals 1 percent to 2 percent of the loan balance. For example, a $200,000 loan with a 1.5 percent single-premium fee results in a one-time payment of $3,000.
In exchange for a higher interest rate, the lender pays for the PMI premium. Lender-paid PMI, or LPMI, also allows you to avoid the additional monthly payment, although it does slightly increase your payment through a higher rate. Additionally, the rate remains on your loan for the duration of the repayment term, Mortgage Currentcy advises. Benefits include a larger tax write-off, as mortgage interest is deductible. LPMI typically increases your rate by .4 percent to .6 percent, according to Really Great Rate.
You can cancel PMI under certain circumstances. Federal law requires your lender to automatically cancel the premium when you pay your loan down to 78 percent of its original balance. Your lender might also cancel the premium based on a new appraisal that indicates you have 20 percent to 25 percent equity in the home. Your property may increase in value through rising home prices in your area and significant improvements made to the property, such as an upgraded kitchen or room addition.
Karina C. Hernandez is a real estate agent in San Diego. She has covered housing and personal finance topics for multiple internet channels over the past 10 years. Karina has a B.A. in English from UCLA and has written for eHow, sfGate, the nest, Quicken, TurboTax, RE/Max, Zacks and Opposing Views.