What is private mortgage insurance?
Private mortgage insurance, also called PMI, is a type of mortgage insurance you might be required to pay for if you have a conventional loan (see below). Like other kinds of mortgage insurance, PMI protects the lender — not you — if you stop making payments on your loan.
PMI is arranged by the lender and provided by private insurance companies. PMI is usually required when you have a conventional loan and make a down payment of less than 20 percent of the home’s purchase price. If you’re refinancing with a conventional loan and your equity is less than 20 percent of the value of your home, PMI is also usually required.
What is a conventional loan?
“Conventional” just means that the loan is not part of a specific government program. Conventional loans typically cost less than government-insured Federal Housing Administration (FHA) loans but can be more difficult to get. There are two main categories of conventional loans:
Conforming loans: Have maximum loan amounts that are set by the government. Other rules for conforming loans are set by Fannie Mae or Freddie Mac, companies that provide backing for conforming loans.
Non-conforming loans: Are less standardized than conventional loans. Eligibility, pricing, and features can vary widely by lender, so it’s particularly important to shop around and compare several offers.
How do I pay for PMI?
There are four different ways to pay for PMI. Some lenders may offer more than one option, while other lenders do not. Before agreeing to a mortgage, ask lenders what choices they offer.
1. Borrower-paid PMI (BPMI)
- Borrower-paid monthly mortgage insurance is the most common type and is often known simply as “PMI.” It is the “default” type of PMI, and the payment is tacked onto the regular mortgage payment.
- BPMI can be canceled. You pay it until your loan principal drops to 78% of the home’s value. In other words, it drops off when you reach 22% equity in your home. This percentage is based on the lesser of the original purchase price or current appraised value.
- BPMI might be the right choice for a buyer who is unsure how long they will stay in the home or keep the mortgage.
- There is no upfront cost to this type of PMI, and no waiting period to cancel it via a refinance or lump-sum payment to your principal loan balance.
2. Lender-paid PMI (LPMI)
- With LPMI, the lender “pays” your mortgage insurance for you. But they don’t do it for free. Instead, they raise your mortgage rate. A higher rate enables the lender to cover the cost of a lump-sum buyout of your mortgage insurance.
- Home buyers who choose lender-paid mortgage insurance might have a lower mortgage payment than if they paid PMI monthly. Having a lower monthly mortgage payment could mean qualifying for more home.
- It’s important to note however, that LPMI cannot be canceled. The mortgage insurance is built into the interest rate, and the rate does not go down when the homeowner reaches 22% equity.
- So, LPMI might be a good solution for a home buyer planning to stay in the home or keeping the mortgage for five to ten years. It typically takes 11 years to build enough equity to cancel a borrower-paid mortgage insurance policy.
3. Single premium PMI
- Single premium PMI allows the homeowner pay the mortgage insurance premium upfront in one lump sum, eliminating the need for a monthly PMI payment.
- It’s somewhat like lender-paid mortgage insurance in that there’s a buyout of PMI in the beginning. But instead of receiving the higher rate like with LPMI, the home buyer pays for the buyout in cash, or by financing it into the loan amount.
- Single premium PMI results in a lower monthly payment compared to paying PMI monthly, which helps the buyer qualify for more home.
- The risk to paying a single premium policy upfront is that the premium is non-refundable, so if for any reason you sell or refinance the home after only a few years, you have paid more than you needed to.
- If rates drop and you refinance in a few years, for instance, you lose that upfront payment, or have a higher loan amount because of it.
4. Split premium PMI
- Probably the least common type of private mortgage insurance is split premium mortgage insurance. While uncommon, it is a good option, allowing the homeowner to pay a portion of the insurance in a lump sum at closing.
- The remaining amount is then paid in monthly installments. The home buyer gets a sharp discount on their monthly PMI since a portion was paid upfront.
Split premium example
For instance, a home buyer purchases a home for $250,000. He pays 1.0% upfront ($2,500) to the mortgage insurance company. His monthly mortgage insurance drops to $83 per month, from $123. In this case, it would take five years to make back the upfront payment. Split premium PMI might prove useful to someone who has extra cash, but is above the typical 43 percent debt-to-income ratio maximum. Making a partial upfront payment could help them bring down their monthly payment enough to qualify.
Lenders might offer you more than one option. Ask the loan officer to help you calculate the total costs over a few different time frames that are realistic for you. Also, you may be able to cancel your monthly mortgage insurance premium once you’ve accumulated a certain amount of equity in your home. Learn more about your rights and ask lenders about their cancellation policies.
Know your options
What factors should you consider when deciding whether to choose a loan that requires PMI?
PMI is offered by a number of companies, so monthly rates can vary. The factors that determine PMI rates are:
- Credit score
- Number of borrowers on the home
- State where the home is located
- Borrower’s total debt-to-income ratio
Like other kinds of mortgage insurance, PMI can help you qualify for a loan that you might not otherwise be able to get. But, it may increase the cost of your loan. And it doesn’t protect you if you run into problems on your mortgage — it only protects the lender.
Lenders sometimes offer conventional loans with smaller down payments that do not require PMI. Usually, you will pay a higher interest rate for these loans. Paying a higher interest rate can be more or less expensive than PMI. It depends on a number of factors, including how long you plan to stay in the home. You may also want to ask a tax advisor about whether paying more in interest or paying PMI might affect your taxes differently.
Borrowers making a low down payment may also want to consider other types of loans, such as an FHA loan. Other types of loans may be more or less expensive than a conventional loan with PMI, depending on your credit score, your down payment amount, the particular lender, and general market conditions.
You may also want to consider saving up the money to make a 20 percent down payment. When you pay 20 percent down, PMI is not required with a conventional loan. You may also receive a lower interest rate with a 20 percent down payment.
Ask lenders to show you detailed pricing for different options so you can see which option is the best deal.
As mentioned above, private mortgage insurance protects the lender, not you. If you fall behind on your payments, PMI will not protect you and you can lose your home through foreclosure. If you have any questions or concerns about PMI, be sure to talk to a qualified lender who can clear away the jargon and explain things in simple terms.