What Is PMI

Mar 21, 2022 | Mortgage Guides

What Is PMI?

For most conventional loan programs, you will need to make a down payment (DP) of at least 20% of the home’s purchase price. If you can’t make this down payment amount, your lender may still approve your mortgage application – and may require you to purchase private mortgage insurance (PMI). You may also be required to get PMI if your refinancing with a conventional home loan and your equity is less than 20% of the current value of your property.

‍In this article, we’ll talk about what PMI is and how it works. We’ll also answer some of the most frequently asked questions on the topic.

What Is Private Mortgage Insurance For?

Before we talk about PMI, it is important to understand what a conventional loan is. This type of mortgage is not guaranteed by the US Federal Government (such as an FHA, VA or USDA mortgage loan), so it carries a greater risk for the lender for high loan to value mortgage loans. To offset some of the risk, lenders require you to get private mortgage insurance if your DP is less than 20% or if you are refinancing and your equity is less than 20% of the current value of your property.

‍Homeowners insurance is not the same thing as mortgage insurance. Homeowners insurance protects the residential structure. PMI is designed to protect the lender, not the borrower. If you stop making payments on your mortgage, the mortgage insurance company pays the lender for some of the costs related to the mortgage default – this allows the lender to recoup some of the money they lent to you.

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Are There Benefits To Paying for PMI?

While PMI is mainly designed to protect the lender, there are some advantages to getting a loan with a PMI. For instance, it can help you qualify for a mortgage loan, especially if you don’t have a lot of cash on hand to pay for a down payment of at least 20% or if your equity is less than 20% of the current value of the home. 

‍Lenders are more comfortable making mortgages at higher loan-to-values with the added assurance of PMI on the loans, which benefits both the borrower and the lender.

‍Finally, home prices continue to rise. If you wait to save for the down payment, prices for the homes in your preferred area may soon be out of your budget. ‍

How Much Does PMI Cost?

PMI costs vary by the mortgage insurance company and by the borrower’s credit score and other factors. There are three main factors that determine how much your PMI will be:

  • Your credit score: A good to excellent credit score shows that you’re a low-risk borrower. Because of this, you’ll typically be charged lower premiums on your PMI compared to someone with a lower credit score.
  • Your debt-to-income (DTI) ratio: The debt-to-income ratio is computed by adding all your monthly debts and then dividing them by your gross monthly income. This is one-way lenders gauge your ability to repay the money you plan to borrow. The higher your DTI, the higher your PMI will be. Ideally, lenders prefer a DTI of lower than 36% but may consider DTIs that are higher, depending on the loan program.
  • Your loan-to-value ratio: A mortgage’s loan-to-value ratio refers to the relationship between the loan amount and the current market value of the home. For example, if you buy a house and make a down payment of 10%, your LTV will be 90%. Meanwhile, if you put down 5%, your LTV will be 95%. The higher your LTV, the higher your PMI will cost. As we stated, PMI typically will be required for LTVs greater than 80%.

What Are Different The Types Of PMI?

There are several types of PMI:‍

  • Borrower-paid mortgage insurance: This is the most common type of private mortgage insurance. For this option, you pay mortgage insurance premiums as part of your monthly escrow payment. 
  • Lender-paid mortgage insurance: This type of mortgage insurance is paid by the lender, meaning the borrower will not make monthly payments for mortgage insurance.  However, for this type of mortgage insurance, you may pay a higher interest rate on your mortgage or higher lender origination fees instead of paying a separate PMI monthly.
  • Single-premium mortgage insurance: Instead of paying PMI in regular installments, you can pay the premiums in one lump sum. You can do this at the time of loan closing or fold the premiums into your loan principal.
  • Split-premium mortgage insurance: For this type of mortgage insurance, you can pay part of the premiums upfront/upon closing. Then, you pay the rest through monthly installments as part of your monthly escrow payment.

If you choose the lump sum options, keep in mind that if you ever refinance your mortgage, you won’t get back any PMI payments you’ve made in advance.‍

What Is PMI | Wesley Mortgage

How Can I Avoid Paying PMI?

Not everybody has the cash to cover 20% of the purchase price on a property for the down payment. But even so, that doesn’t mean that you have no choice but to pay PMI. If you want to avoid this additional expense, you may want to consider the following options:

Get A Piggyback Loan

Consider getting a smaller “piggyback” loan to cover the 20% down payment. Although you’ll be committed to paying off two loans, you won’t be required to pay PMI. 

Choose Other Types Of Loans

Instead of getting a conventional loan that will require PMI, you can apply for other types of loans, like the following:

  • Department of Veterans Affairs (VA) Loans: VA loans are available to members of the military, veterans, and their surviving spouses. This type of mortgage doesn’t require a down payment, and in lieu of monthly mortgage insurance payments, VA loans require an upfront mortgage guaranty fee.
  • A loan program offered by your lender that does not require PMI.

Reconsider The Purchase

If you can’t pay the 20% DP on the property you’re eyeing, consider lowering your maximum budget and looking at other homes with a lower purchase price. That way, it’ll be much easier to meet the 20% DP requirement.

Can I Stop Paying PMI?

When your loan balance reaches 80% of the purchase price/value of the property at the time of origination, you can request your servicer to drop the PMI.  Certain qualifications and restrictions apply to this option.  At 78%, your servicer should drop PMI as long as your payments are current at that time. 

If not already canceled, final cancellation must take place no later than the midpoint of the amortization of your mortgage loan, as long as the payments are current at that time.

Final Thoughts

Private mortgage insurance makes your monthly mortgage payments more expensive. However, if you can’t pay 20% of the purchase price upfront, loans with PMI can be a great option. It may allow you to qualify for a conventional mortgage and help you become a homeowner as soon as possible.

‍If you want to learn more about private mortgage insurance and low-down payment home loans, get in touch with Wesley Mortgage! We’ll be happy to talk to you about your options.

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