PMI. Most home buyers have it, but many don’t know why. If you’ve ever had a conventional mortgage or currently are shopping around for one, you probably have come across mention of private mortgage insurance, or PMI. Required by most lenders in conventional financing, PMI adds thousands of dollars to your housing costs. Find out what PMI is, when you might need it, and how to avoid it all.
You pay for PMI, but it’s not protecting you. PMI is a type of insurance that protects your lender in case you stop making payments on your mortgage. If you default on your home loan, the PMI covers a portion of the balance due to the mortgage lender. You pay a monthly premium to the insurer on the lender’s behalf.
If you’re not able to make a large enough down payment, then you’ll probably be stuck paying PMI. Conventional lenders require PMI with down payments of less than 20 percent because they are assuming additional risk by accepting a lower amount of money toward the purchase upfront. When the loan-to-value ratio (LTV) is 80 percent or more, most lenders will require PMI. Loan-to-value simply calculates the amount of the loan divided by the value of the home based on purchase price.
In the majority of non-cash home purchases, lenders require PMI. Despite the long-standing target of a minimum 20 percent down payment when buying a house, most Americans fall short of that goal. In December 2019, more than half of all home purchases made through financing had less than a 20 percent down payment, and 76 percent of first-time, non-cash home buyers put down a payment of less than 20 percent.
Some lenders waive PMI in exchange for a higher mortgage interest rate.
Like other types of insurance, PMI calculates based on insurance rates that can change daily as well as a number of other factors. PMI typically costs between 0.5 to 1 percent of your loan amount per year, but the average annual cost of PMI can range up to 2.25 percent of the original loan amount.
Several factors determine the cost of PMI:
- Amount of down payment: The greater the down payment, the lower the PMI.
- Size of mortgage: PMI increases with the amount of the mortgage.
- Your credit history: PMI rates will be lower if your credit score is higher.
- Type of mortgage: Fixed-rate mortgages typically cost less in PMI than an adjustable-rate mortgage (ARM). An ARM in which the rate might increase over time is riskier than a fixed-rate loan, which has consistent mortgage payments. Less risk can lead to a lower PMI rate.
Given that PMI adds up to several thousand dollars a year to your housing costs, you probably would welcome a reduction or elimination of this insurance. You’re in luck. You have a few options for avoiding PMI altogether, lowering your PMI rate, and cancelling the coverage eventually.
If you can’t make a down payment of at least 20 percent of the purchase price, you probably can’t avoid the PMI requirement. But the greater the amount you can contribute upfront, the greater amount of equity you will have, thus lowering the perceived risk associated with your loan. Lower risk = lower PMI.
When you have a positive credit history that reflects a pattern of repaying your debts and a low amount of existing debt relative to your income, you present less risk of defaulting on your mortgage. The less riskier you appear to lenders, the less PMI you must have.
An alternative to paying PMI at all is to use a “piggyback” loan. You obtain a first mortgage in an amount equal to 80 percent of the home value, which thus avoids the PMI requirement, and you also take out a second mortgage in an amount equal to the sale price of the home less the amount of your down payment and less the amount of the first mortgage.
Federally-guaranteed loans do not have PMI requirements, though some require payments similar to PMI. Loans backed by the U.S. Department of Veterans Affairs and the U.S. Department of Agriculture do not require mortgage insurance, though they do include a “funding fee.” FHA loans require its own form of mortgage insurance premiums, with one paid upfront and another paid annually.
Under federal law, you have certain rights related to cancellation of PMI:
- You have the right to request that your loan servicer cancel PMI when you have reached the scheduled date that your mortgage’s principal balance should reach 80 percent of your home’s original value.
- You can ask for earlier cancellation of PMI if you made additional payments so your mortgage’s principal balance equals 80 percent or less of the original value of your home.
- You can request PMI cancellation if the appraised value has increased significantly and the mortgage’s principal balance equals 80 percent or less of the newly appraised amount.
- Your loan servicer must automatically terminate PMI on the scheduled date when your principal balance should reach 78 percent of the original value of your home, as long as you are current on your payments on the anticipated termination date.
- Your loan servicer must automatically terminate PMI the month after you reach the midpoint of your loan’s amortization schedule, as long as you are current on your payments. The midpoint for a 30-year loan would be after 15 years have passed.
If you request PMI termination, you must comply with the following:
- Your request for cancellation must be in writing.
- You must be current on your mortgage payments.
- The lender might require you to certify that there are no junior liens, such as a second mortgage, on your home.
- The lender might require you to provide evidence that the appraised value of your property has not declined below the original value of the home.
We at LemonBrew understand the home buying process can be a complicated one, but we’re here to help you. Have questions about PMI? We can offer guidance. From matching you with a local real estate agent to helping you find your perfect home to providing mortgage services to help find the right home loan, LemonBrew is there for you during one of the largest and most meaningful purchases of your life.