What Is PMI?

What Is PMI?
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PMI, or private mortgage insurance, covers your mortgage lender and protects their financial interests if you stop paying your mortgage. Typically required for conventional loans where the borrower puts less than 20 percent ​down, PMI costs may vary based on the loan amount and the down payment amount.

It’s important to remember that PMI protects the lender, not the borrower. Nonetheless, agreeing to PMI insurance can make it easier for a borrower to obtain a mortgage at a lower interest rate, even if they can’t put ​20 percent​ down.

How Much Does PMI Cost?

Factors that affect the PMI cost include:

  • The total value of the mortgage loan
  • Your down payment
  • Your FICO credit score 
  • Your credit history

The first two factors, together, make up the loan-to-value ratio (LTV). If you purchase a house for ​$200,000​ and you only put down ​10 percent​, or ​$20,000​, your loan-to-value ratio would be ​90 percent​. That means you are borrowing ​90 percent​ of the home’s value.

PMI costs can range anywhere from ​0.19 percent​ up to about ​2 percent​ of the total loan balance annually. The Urban Institute reports average private mortgage insurance premiums at anywhere from ​0.58 to 1.86 percent​ of the total loan with an LTV of ​96.5 percent​, depending on your credit score during loan origination.

As you pay down your loan and the principal goes down, your PMI costs may drop.

Additionally, borrowers with a better credit score may enjoy lower premiums. Urban Institute statistics say that home buyers with a FICO score of ​760+​ may get rates as low as ​0.58 percent​ of the loan. That percentage would drop further if you put more than ​3.5 percent​ down, but that is the minimum down payment most mortgage companies will accept.

Mortgage lenders evaluate the PMI premiums annually as homeowners continue paying off their loans.

Most borrowers pay their PMI premiums as an additional cost at closing, plus added payments to their monthly mortgage payment. The mortgage bill also includes principal, interest, taxes, and homeowners’ insurance.

You may prefer to make a lump sum payment of your PMI total at closing. But this isn’t a smart choice if you plan to sell the property soon, because PMI is usually not refundable.

How to Cancel Your PMI

Once you reach an LTV of ​78 percent​ on your home loan or your loan has reached the mid-way point, according to the National Credit Union Administration, the lender must automatically terminate your PMI if you're current on payments.

However, you can be proactive and contact your lender once you’ve reached an LTV of ​80 percent​. If you’ve made your mortgage payments on time and your credit score is good, your lender will likely cancel the private mortgage insurance for you once you make the request, resulting in a lower monthly mortgage payment. Some lenders require a home assessment and appraisal to be sure you have at least ​20 percent​ equity in your home.

Remember, too, that lenders may not follow the Homeowners Protection Act and automatically cancel your PMI. Read your statements carefully, and if you reach ​80 percent​ LTV, you should contact your mortgage lender to evaluate your loan profile.

Why Should You Take Out a Home Loan That Includes PMI Charges?

Now that you know what PMI is and how much it costs, you may be wondering why you’d want to increase your monthly mortgage payments with something that protects the lender and doesn’t benefit you.

The answer is easy: If you don’t have a ​20 percent​ down payment for the home you want, but -you have good credit and a good debt-to-income ratio, paying PMI paves the path to faster homeownership.

When you purchase a home, you build equity in your investment. You can borrow against that equity in the future to pay off higher interest credit card debt. And if you sell your home, you can walk away with money for a down payment on another house.

On the other hand, if you continue to rent your home, you aren’t building equity. You pay your rent and that money disappears into your landlord’s bank account. For many, homeownership can launch a path to financial freedom.

Keep in mind, you might be able to get a conventional loan that doesn’t require PMI with less than ​20 percent​ down. But you might pay a higher interest rate. Do the math to determine the best choice for your wallet.

Types of Private Mortgage Insurance

Insurance carriers offer different types of PMI for home buyers. Depending on your situation, you may be able to negotiate for the type of PMI that fits your budget best.

Borrower-Paid Mortgage Insurance (BPMI):​ The most common form of mortgage insurance, the borrower pays the premium in the form of an additional fee on their mortgage each month.

Single-Premium Mortgage Insurance (SPMI):​ Don’t let the name fool you; the borrower also pays the premium for SPMI. But the home buyer pays it in one lump sum at closing. Purchasing SPMI may help you to quality for a larger mortgage, since your monthly mortgage payments will be lower.

But beware that SPMI is usually not refundable should you sell the home, so if you plan to sell in less than three years, you could lose money paying your mortgage insurance premiums up front.

One advantage of SPMI is that you may be able to negotiate to have the seller or the home builder (for a new home) cover the SPMI premium.

Lender-Paid Mortgage Insurance (LPMI):​ Sometimes, the lender pays the mortgage insurance premium. Typically, however, you’ll pay a higher interest rate instead. You need to do the math to see if this trade-off pays. Additionally, you can’t cancel LPMI when you reach a ​78 percent​ LTV; you would have to refinance the home to get rid of LPMI.

Split-Premium Mortgage Insurance:​ With this combination of BPMI and SPMI, you pay a portion of the PMI at closing, and the rest is added to your mortgage payments. This can help keep your monthly payments low while also reducing your closing costs. You might be able to roll the initial premium into your mortgage or ask the seller to pay the upfront premium.

Federal Home Loan Mortgage Insurance Protection:​ The Federal Housing Administration permits some home buyers to secure a mortgage with just ​3.5 percent​ down and no PMI. However, the FHA requires another form of mortgage insurance, called “mortgage insurance protection" (MIP) on any mortgages with an LTV of ​90 percent​ or more. Borrowers with FHA loans pay MIP in part at closing and the rest as a monthly fee.

Summary: PMI Pros and Cons

PMI has various pros and cons depending on your current financial situation and the cash you have on hand. Consider these advantages and disadvantages of PMI payments before you seek out a loan requiring private mortgage insurance.

PMI Pros

PMI has a couple of benefits. It allows home buyers to purchase a property with ​less than 20 percent​ down. PMI may also reduce your interest rates, allowing you to buy more home for your money with lower mortgage payments.

PMI Cons

PMI increases your monthly mortgage payments. It also protects the seller, not the borrower. And if you miss a mortgage payment, it may not be as easy to get the lender to drop PMI, even if you reach an LTV of ​80 percent.