What is private mortgage insurance (PMI)?
Learn about the purpose and implications of private mortgage insurance (PMI) and how it affects homebuyers and their mortgage loans.
Private Mortgage Insurance (PMI) is a type of insurance that lenders typically require from borrowers who make a down payment of less than 20% when purchasing a home. PMI is designed to protect the lender in case the borrower defaults on the mortgage. It is an additional cost that borrowers with smaller down payments must pay as part of their monthly mortgage payments. Here are key points to understand about PMI:
Purpose of PMI:
- PMI is meant to mitigate the risk for lenders when borrowers have a lower equity stake in their homes. If a borrower defaults on their mortgage, the lender may not recover the full amount through foreclosure and sale of the property. PMI helps cover the lender's potential losses.
- PMI costs can vary depending on factors like the size of the down payment and the borrower's credit score. Typically, PMI costs between 0.3% and 1.5% of the original loan amount annually. The cost is divided into monthly payments and added to the borrower's mortgage payment.
- In many cases, PMI can be automatically terminated when the borrower's equity in the home reaches 20% or more. This can occur through a combination of regular mortgage payments and property value appreciation. Borrowers can request the removal of PMI once they believe they have met the 20% equity threshold.
Requesting PMI Cancellation:
- Borrowers can usually request the cancellation of PMI once their equity reaches 20%. However, they may need to meet specific criteria, such as having a good payment history and providing a current appraisal to confirm the home's value.
- In some cases, lenders may offer lender-paid PMI (LPMI) as an alternative. With LPMI, the lender pays the PMI premium but typically charges a slightly higher interest rate to compensate. Borrowers should compare the long-term costs of LPMI versus borrower-paid PMI to determine which option is more cost-effective.
- Some government-backed mortgage programs, such as FHA (Federal Housing Administration) and USDA (U.S. Department of Agriculture) loans, require borrowers to pay mortgage insurance premiums (MIP) or guarantee fees, which serve a similar purpose to PMI.
- In the past, PMI premiums were tax-deductible for eligible borrowers. However, the deductibility of PMI premiums depends on changes in tax laws. Borrowers should consult with a tax professional to determine whether PMI premiums are deductible in a given tax year.
PMI can significantly increase the monthly cost of homeownership, so borrowers often aim to reach the 20% equity mark as soon as possible to eliminate this expense. It's important for borrowers to carefully review their mortgage agreement, understand the terms of PMI, and be aware of the options for PMI removal or cancellation as they work to build equity in their homes.
Demystifying Private Mortgage Insurance (PMI).
Private mortgage insurance (PMI) is a type of insurance that protects the lender if you default on your mortgage loan. It is required for conventional loans when you make a down payment of less than 20% of the purchase price of the home.
PMI is typically added to your monthly mortgage payment, but it can also be paid in a lump sum at closing. The cost of PMI varies depending on the loan amount, the down payment amount, and the credit score of the borrower.
PMI is not required for government-backed loans, such as FHA loans and VA loans.
How does PMI work?
If you default on your mortgage loan, the lender can foreclose on your home and sell it to recoup their losses. However, if the sale of the home does not cover the full amount of the loan, the lender will lose money.
PMI protects the lender from these losses. If you default on your loan, the PMI company will pay the lender the difference between the amount of the loan and the sale price of the home.
When does PMI go away?
PMI will automatically be canceled once you reach 22% equity in your home. Equity is the difference between the value of your home and the amount of money you owe on your mortgage.
You can also request to have PMI canceled manually once you reach 20% equity in your home. However, you will need to meet certain requirements, such as having a good credit score and making all of your mortgage payments on time.
Is PMI worth it?
Whether or not PMI is worth it depends on your individual circumstances. If you can afford to make a 20% down payment, then you will not need to pay PMI. However, if you cannot afford to make a 20% down payment, then PMI may be the only way for you to qualify for a mortgage.
If you do have to pay PMI, it is important to remember that it is temporary. Once you reach 22% equity in your home, PMI will automatically be canceled.
How to avoid PMI
The best way to avoid PMI is to make a down payment of 20% or more of the purchase price of the home. However, if you cannot afford to make a 20% down payment, there are a few other things you can do to avoid PMI:
- Consider a government-backed loan. FHA loans and VA loans do not require PMI, even if you make a down payment of less than 20%.
- Ask your lender about PMI alternatives. Some lenders offer PMI alternatives, such as lender-paid mortgage insurance (LPMI). LPMI costs more than PMI upfront, but it is typically canceled once you reach 20% equity in your home.
- Shop around for a lender. Some lenders offer lower PMI rates than others.
If you are considering a mortgage, it is important to talk to a financial advisor to discuss your individual situation and to get help choosing the best option for you.