During the loan process, private mortgage insurance (PMI) allows borrowers to purchase a home without making a 20 percent down payment on a conventional mortgage. The caveat? PMI also adds to the cost of your mortgage – and how much you pay will depend on the size of the loan and your credit score.
In this article, we’ll take a look at how much PMI impacts the cost of your mortgage, how to avoid paying it, and more.
What Is PMI and Why Do You Pay It?
PMI is a type of mortgage insurance that is required for conventional mortgages with down payments of less than 20 percent. Borrowers may also be required to pay private mortgage insurance if they refinance with a conventional loan and have less than 20 percent equity in the home.
When homebuyers put less than 20 percent down, lenders take on additional risk with the loan. PMI serves as extra protection for the lender in case the borrower defaults on their mortgage.
If you’re required to pay PMI, your lender will arrange it with a private insurance company. From there, you’ll either pay the premium in a lump sum or gradually with your monthly mortgage payments.
Is There PMI for Government-Backed Loans?
Government-backed mortgages work a little differently with their insurance requirements. Let’s quickly break them down:
- Loans insured by the Federal Housing Administration (FHA) require a mortgage insurance premium (MIP). This includes an upfront charge and annual charges regardless of the down payment amount. Because of this extra protection, FHA loans offer much lower down payment and credit score requirements that are ideal for first-time buyers.
- USDA loans similarly require an upfront fee (one percent of the loan amount) and an annual fee (about 0.35 percent).
- The U.S. Department of Veterans Affairs (VA) doesn’t require any type of mortgage insurance for VA loan products.
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What Does PMI Cover?
If a borrower defaults on their mortgage, PMI helps protect the lender against potential losses.
When a loan goes into default, the lender can reclaim the property through foreclosure. Properties in foreclosure are usually sold at auction to the highest bidder. If the home doesn’t sell for the remaining principal balance, PMI can help cover the difference.
For example, if the remaining principal balance on a home is $120,000 but the home sells for $105,000, private mortgage insurance will pay the lender $15,000.
How Much Does PMI Cost?
According to mortgage insurance data from the Urban Institute, PMI costs between 0.58 to 1.86 percent of the loan amount.
For every $100,000 borrowed, Freddie Mac says that you can expect to pay between $30 and $70 per month in PMI.
The cost of PMI depends on two factors:
- Your loan-to-value (LTV) ratio: LTV is the ratio of the value of the property to the amount of outstanding loan balance. If you put down 10 percent on the mortgage, for example, then the LTV will be 90 percent. The higher the LTV, the greater the risk for the mortgage lender.
- Your credit score: Borrowers with higher credit scores usually end up getting a better PMI rate. Data from the Urban Institute shows that for a buyer with a FICO score of 760 or greater purchasing a $275,000 property with a 3.5 percent down payment, the monthly mortgage payment including PMI is $1,241. With a FICO score between 620 and 639, the monthly payment is $1,604.
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How To Avoid Paying PMI
The easiest way to avoid paying PMI is to make a down payment of at least 20 percent of the purchase price of the home. This means that for a $350,000 home, you would need to put down at least $70,000 to avoid paying PMI. This would put your LTV ratio at 80 percent.
However, a 20 percent down payment isn’t a small amount and is not always possible. Here’s how to get rid of private mortgage insurance:
- Appreciation: If the value of your home increases and reduces your LTV below 80 percent, you can ask your lender to cancel PMI. However, the lender may require a second appraisal of your home to fully remove PMI.
- 80-10-10 loan: Also known as a piggyback mortgage, 80-10-10 loans allow borrowers to avoid PMI by taking out a home equity loan or second mortgage at the same time as the first mortgage. The mortgage covers 80 percent of the purchase price, the second loan covers 10 percent, and your down payment covers the remaining 10 percent.
- No PMI home loan: No PMI mortgages do exist, but it also means you’ll pay a higher interest rate. In this situation, the lender pays the PMI premium.
- VA loan: Home loans through the U.S. Department of Veterans Affairs don’t require PMI.
Removing Private Mortgage Insurance
Removing private mortgage insurance on a conventional loan requires an LTV ratio of 80 percent. This means that if you took out a mortgage for $300,000, then you must have $60,000 equity in your home. This is what you’ve paid towards the principal balance, not including any interest.
Once you’ve built 20 percent equity, you can contact your lender and request to cancel your PMI. If you forget to contact your lender, your PMI will automatically be canceled once you reach 22 percent equity.
To reach 20 percent equity more quickly, you can make extra payments toward your principal to reduce the balance. Additional payments can also help save you money in interest.
Consider a Home Loan With Total Mortgage
Private mortgage insurance adds to the overall cost of your home loan – but there are ways to avoid paying it. When you’re shopping for a mortgage, be sure to discuss PMI with your lender to set expectations for your monthly payments.
Be sure to explore Total Mortgage’s loan program options when you’re ready to purchase a home.
If you have questions about your home loan options with Total Mortgage, make sure to schedule a meeting with one of your mortgage experts. We have branches across the country.
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