How Is Mortgage Insurance Calculated?

Aug 10, 2022 | Mortgage Guides

Calculating Mortgage Insurance: Understanding the Factors and Formulas

When buying a new home or refinancing an existing mortgage, additional expenses often follow. For many folks, one is private mortgage insurance (PMI). That is a separate policy from homeowners insurance coverage and instead protects the lender involved in the mortgage transaction. PMI is often required based on the borrower’s loan-to-value (LTV) ratio but is not always necessary.‍

It’s prudent to be curious about the extra costs attached to your mortgage. If PMI appears on the estimate, you may wonder, what is that? Why is it required? Who provides it? And how much is it? Discover the answers to these questions and learn how to calculate the cost of mortgage insurance in this guide.‍

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What Is Private Mortgage Insurance?

Private mortgage insurance is imposed by conventional lenders when homebuyers have a high loan-to-value ratio. Considering the amount of most home loans, lenders often take on a great deal of risk. They have to draw the line somewhere, and PMI is often their solution to balance that out.‍

Even though the borrower is responsible for paying for PMI, the policy protects the lender. If the mortgage defaults, the policy would reimburse the lender with a portion of the unpaid loan balance. While PMI may not cover the borrower, it can still benefit them. For instance, it may help homebuyers qualify for mortgage loans they otherwise would not be eligible for.‍

When Is PMI Necessary?

Whether purchasing or refinancing a home, lenders mandate borrowers pay PMI if they cannot meet their financial benchmarks.

‍Most conventional lenders require a down payment of at least 20 percent of the purchase price when buying a home. If less than 20 percent, PMI is often necessary. To determine a down payment percentage, divide the estimated upfront payment amount by the property’s price.

‍When refinancing a home loan, most conventional lenders require an LTV ratio of less than 80 percent. If this percentage surpasses 80, the borrower may have to pay PMI. To determine the LTV ratio, divide the new mortgage amount by the home’s fair market value.‍

Who Provides PMI?

Unlike homeowners insurance, borrowers do not select their PMI provider. The mortgage lender is responsible for making these arrangements with their providers, saving homebuyers the extra hassle. That means in the event that PMI is required, the lender decides on the amount and payment plan. The policy is then linked to the borrower’s loan and included in their monthly mortgage payment.‍

What Is the Cost of PMI? 

According to a 2021 report from the Urban Institute, the average PMI costs range between 0.58 percent to 1.86 percent of the mortgage loan amount. Assessments from Freddie Mac predict the PMI amount to be between $30 and $70 per month for every $100,000 borrowed. Where an individual falls within that range depends on two factors.

The first is their credit score – the lower the score, the more risk, so PMI costs are higher. The second factor is the total loan amount – larger mortgages pose more uncertainty, hence higher PMI costs. Most lenders have PMI charts that give specific percentages based on the borrower’s status.

How to Calculate the Cost of Mortgage Insurance?

Conventional mortgage insurance varies for each homebuyer. The cost is calculated based on the borrower’s loan-to-value ratio and the rate assigned by the lender. To figure out the cost of your PMI, follow the detailed steps below:

  1. Determine the Property Value: When assessing the cost of mortgage insurance, you’ll need to know the property value. A home appraisal should give the exact amount for the property. If not, estimate it by using the price intended to be spent or offered on the house.
  2. Identify the Total Loan Amount: This figure should be less than the property value as it only accounts for the borrowed costs. For new home loans, subtract the down payment from the listing price. For refinancing, use the balance of your current mortgage.
  3. Calculate the Loan-to-Value (LTV) Ratio: To find out the LTV ratio for a mortgage, divide the total loan amount (step two) by the home’s property value (step one). For a percentage figure, multiply the result by 100. If the outcome is less than 80 percent, PMI is not necessary. Continue to the next step if the percentage is more than 80 percent.
  4. Find Out the Mortgage Insurance Rate: The most precise way to determine PMI rates is to ask the mortgage lender. If you can’t specify the exact rate, use the average range, with 0.58 percent being the low end and 1.86 percent being the high end.
  5. Estimate the Annual & Monthly Premium: Mortgage insurance can be paid through annual or monthly installment plans. To calculate the yearly PMI premium, multiply the PMI percentage rate (step four) by the total loan amount (step two). For the monthly premium, divide the results by twelve.‍

How to Stop Paying Mortgage Insurance

Homebuyers can often forgo paying private mortgage insurance. How? Avoid PMI altogether by making a downpayment of at least 20 percent of the purchase price. Review your savings and consult a lender to determine the largest affordable down payment. If unable to meet the 20 percent mark and PMI is required, the good news is that it does not last forever.

Following are multiple ways to reduce or even remove PMI payments over time:‍

Build Up Home Equity

Mortgage lenders are mandated to stop charging PMI once a borrower’s LTV ratio reaches 78 percent. Often, folks continue their mortgage insurance payments until they’ve built enough home equity to reach that LTV benchmark. That does not pertain to an FHA mortgage, where borrowers must pay at least ten percent of their home and continue repayment for at least 11 years before canceling their PMI.‍

Get an Updated Home Appraisal

Paying down a loan’s principal amount is not the only way to reach the elusive 78 percent mark. If a home’s value has appreciated since purchase, having it appraised again may wipe away the loan’s PMI. On average, home appraisals cost between $300 and $400, a small price considering how much they can save in future mortgage payments. Consider having your home evaluated by a professional to see if this is viable.

Refinance After Paying Down Mortgage Balance

Refinancing a home is another option that may lower or cancel out mortgage insurance. Before refinancing, consider paying down more of the balance first to ensure the LTV ratio meets the necessary threshold. Note that this choice includes a home appraisal and further costs, making it more expensive than the alternatives. Consult with a lender to plan the best course of action or use a refinance calculator.

Ask About Higher-Interest Loans

Sometimes, getting the LTV ratio below 80 percent is a challenge. Conventional mortgage lenders may offer other possibilities for borrowers. One is higher-interest loans, which help level out lenders’ risk without requiring PMI. Ask your lender for a comparison between a high-interest loan with no PMI versus a standard loan with PMI to learn which saves more money.

Bottom Line

Private mortgage insurance (PMI) is an additional expense that, while often unwanted, can help homebuyers get their foot in the door early. Knowing how to calculate PMI, borrowers can determine whether it fits in with their homeownership goals when buying or refinancing. Wesley Mortgage can help you find the best rate and terms in your home-buying journey. 

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