Private mortgage insurance, or PMI, allows borrowers to purchase a home without making a 20% down payment on a conventional mortgage. PMI also adds to the cost of your mortgage, and how much you pay depends on the size of the loan and your credit score.
Let’s take a look at private mortgage insurance, how much it impacts the cost of your mortgage, and how to avoid paying PMI.
What Is PMI and Why Do You Pay PMI?
PMI is a type of mortgage insurance that borrowers are typically required to pay on a conventional mortgage if they make a down payment of less than 20% of the home’s purchase price. Borrowers may also be required to pay private mortgage insurance if they refinance with a conventional loan and have less than 20% equity in the home.
When homeowners put less than 20% down, lenders are assuming additional risk. PMI is extra protection for the lender in case the borrower defaults on their mortgage.
If you’re required to pay PMI, the lender will arrange it with a private insurance company and the premium will either be paid in a lump sum or be added to your monthly mortgage payment.
Government-backed mortgages work a little differently.
Mortgages insured through the Federal Housing Administration require a mortgage insurance premium (MIP), which includes an upfront charge and an annual charge regardless of the down payment amount. USDA loans also require an upfront fee and annual fee but loans backed by the U.S. Department of Veterans Affairs don’t require any type of mortgage insurance.
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% 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% on the mortgage, then the LTV is 90%. 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% 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% of the purchase price of the home. This means that on 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%.
However, a 20% down payment isn’t a small amount and it’s 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%, you can ask your lender to cancel PMI. But, the lender may require an appraisal.
- 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% of the purchase price, the second loan covers 10%, and your down payment covers the remaining 10%.
- 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%. 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% equity, you can contact your lender and request that they cancel your PMI. If you forget to contact your lender, PMI will automatically be canceled once you reach 22% equity,
To reach 20% equity more quickly, you can make extra payments towards 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 PMI. When you’re shopping for a mortgage, make sure to discuss PMI with each lender to figure out how much you can expect to pay.
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.