What Is PMI? Here’s What You Need to Know About Private Mortgage Insurance | Mortgages and Advice

[ad_1]

Many lenders allow a 5%, 3% or even 0% down payment for a mortgage, so it’s no wonder some buyers are choosing not to put down the traditional amount of 20% when they buy a home. A downside of a down payment below 20% is that a buyer will need to pay private mortgage insurance possibly every month for several years.

If you’re wondering what PMI is, here’s an introduction to how it works and some tips on how to stop paying it as soon as possible.

What Is Private Mortgage Insurance?

PMI is an insurance policy that protects the lender in case you default on your mortgage.

“Mortgage insurance is generally required when the loan-to-value ratio is higher than 80%,” says Ron Haynie, senior vice president of mortgage finance policy for the Independent Community Bankers of America.

If you’re putting down less than 20% of the appraised value at closing for a home purchase or refinance, then your LTV ratio is higher than 80% and PMI is likely to be required.

How PMI Differs From Other Mortgage Insurance

While PMI is used for what’s known as conventional mortgage loans – which are backed by Fannie Mae and Freddie Mac – there is a different loan insurance arrangement for some federal mortgage loans.

Federal Housing Administration loans can be obtained through a variety of lenders and are backed by the U.S. government. They allow for a down payment as low as 3.5%, but mortgage insurance is often required for the life of the loan. The insurance costs include an upfront fee of 1.75% of the purchase price that could be financed into the loan, plus annual costs of 0.55%% of the loan.

Compare Top Mortgage Lenders

Min. Down Payment
Min. Credit Score
Min. Down Payment
Min. Credit Score
Min. Down Payment
Min. Credit Score

How Much Does PMI Cost?

Expect to pay from 0.5% to 2% of your loan amount for your annual mortgage insurance premium. For a $250,000 mortgage, that could be $1,250 to $5,000 yearly. That’s about $100 to $420 per month.

Your PMI cost depends on several factors. These may include:

  • The home price. The larger the mortgage, the more risk the lender is taking on. Therefore, it’s likely that someone borrowing $450,000 would have a higher PMI cost than a $300,000 borrower.
  • Your credit score. Your credit plays a role in determining not only your mortgage interest rate, but how much your PMI will cost. Lenders assume they are taking on less risk when borrowers have strong credit histories.
  • The size of your down payment. Usually, the larger your down payment and the closer you are to 20% ownership, the less lenders will charge you for private mortgage insurance.
  • The number of borrowers on the loan. The PMI rate could also be lower if more than one borrower is on the loan and if the home you’re buying will be your primary dwelling.
  • The type of loan. PMI on adjustable rate mortgages, or ARMs, could be more expensive since those types of loans are generally more risky.

How to Pay PMI

You’ll most likely pay PMI in monthly installments that are rolled into your mortgage payments, but you may have the option to make one yearly lump-sum payment. If you’re concerned that your PMI premium is too high – say, it increases dramatically when you refinance compared with your original loan – ask whether your lender can offer a better rate.

Another payment option is to pursue a lender-paid mortgage insurance arrangement. One of the programs lenders might offer is an opportunity to pay a slightly higher interest rate in exchange for not paying for your own PMI. While you can eliminate borrower-paid PMI once the loan-to-value ratio hits 80%, the interest rate for this lender-paid program would stay at the same level regardless of your LTV ratio.

Ways to Avoid PMI

Here are some options if you’re looking to avoid the costs of PMI:

  • Save up 20% for a down payment. Or make sure you have 20% equity in your home if you’re refinancing. This will essentially guarantee you won’t have to pay for PMI. 
  • Borrow money to hit that 20% down payment. Borrowers sometimes opt for a piggyback loan, which is when you purchase a home using two mortgages that total 90% of the price, plus a 10% down payment. A common piggyback loan is an 80-10-10, in which 10% of it is a home equity line or loan.
  • Talk with your lender. Understand how your credit characteristics are impacting your PMI rate. Some borrowers may qualify for programs with no PMI at all, and others may qualify for programs with reduced mortgage insurance rates. Bumping up your credit score can make a big difference in your PMI premium if you do wind up paying it, says Bill Banfield, executive vice president of capital markets for Rocket Mortgage.
  • Find a conventional loan that doesn’t require PMI. This type of loan generally includes lender-paid mortgage insurance and charges slightly higher interest rates to compensate.
  • Look for special lending programs. If finding an affordable loan is proving difficult, look beyond traditional loan products. For example, you may qualify for government programs such as Department of Veterans Affairs loans, which also has refinancing options.

How to Get Rid of PMI

You can take steps that may allow for the early removal of PMI from your loan. Here’s what you can do:

  • Keep track of your LTV. Talk with your loan servicer if your loan-to-value ratio is approaching the 80% mark. That means you have 20% equity. “Servicers are required by law to drop borrower-paid mortgage insurance coverage when the LTV based on amortization drops to 78%,” Haynie says. “However, a borrower can request the coverage be dropped based on a current appraisal if the LTV is 80% or less.”
  • Show that you’re a model borrower. You will need a strong payment history before most lenders will let you try to drop PMI. The lender also might make sure that you don’t have any second liens, or loans that use your home as collateral.
  • Prove your home’s value. To show that your loan-to-value ratio has changed, you might need another home appraisal. The appraisal, whether through a licensed appraiser or broker, can confirm that the property is valued at least as high as the previous appraisal and possibly much higher. You will likely need to pay for the new appraisal yourself in these situations, Haynie says.
  • Accelerate your mortgage payments. Add some extra cash to each of your principal payments to build home equity faster. Not only can you reach 20% equity more quickly, you also work toward paying off your mortgage early. But first check whether you’re subject to a prepayment penalty.
  • Consider refinancing. With interest rates at historic lows, refinancing could save you a lot of money over the lifetime of your loan, even if it doesn’t immediately eliminate PMI. Because refinancing almost always includes an appraisal, you could also find out that you have more equity than you realized.
  • Know the rules. Borrowers usually have to wait at least two years after taking out a loan before PMI can be dropped. 

Do the math to find out how long it will take to build sufficient equity to cancel your private mortgage insurance. You should also receive an annual PMI statement from your loan servicer, which discloses your right to cancel or terminate PMI, along with contact information to remove it.

[ad_2]

Source link

Leave a Comment