What Is Private Mortgage Insurance?
Private mortgage insurance, or PMI, is an extra cost that gets added to mortgage payments when you make a down payment of less than 20 percent of a home’s purchase price. Private mortgage insurance protects the financial institution giving you the loan in case you are not able to pay it back. Private mortgage insurance is required for any conventional loan (meaning the loan isn’t part of a special government program) where the borrower puts less than 20 percent down.
The larger your down payment is, the more equity you have in your home, which makes your loan less risky. Here’s why a 20 percent down payment matters: if your loan-to-value ratio is 80 percent or less, lenders see your loan as less risky, and PMI is not required. For example, if you’re purchasing a $300,000 home, a 20 percent down payment is $60,000. You would have a mortgage loan amount of $240,000, with an 80 percent loan-to-value ratio. If you want to put less than $60,000 down and you’re using a standard fixed-rate or adjustable-rate loan, you’ll have to pay private mortgage insurance.
The good news is that paying PMI can help borrowers with less than 20 percent down get a loan. Instead of simply denying a loan with a 5 percent or 10 percent down payment, lenders may be willing to accept the risk as long as the borrower pays for PMI.
However, when you’re required to pay PMI on a mortgage loan, it becomes an extra portion of your monthly payment. The lender chooses the PMI company and handles all the arrangements for you. You pay the PMI premiums to the lender as part of your mortgage payments. PMI payments don’t reduce your loan balance or offset interest charges. They’re a separate monthly cost that you pay to have the lender approve the loan in the first place.
PMI is also required when refinancing a mortgage if your equity is less than 20 percent of your home’s value. If your home value is $300,000, you’d need to have an outstanding mortgage balance of less than $240,000 in order to avoid paying PMI on your new refinance loan.
If a loan isn’t a conventional loan, private mortgage insurance may not be required. However, many non-conventional loan programs have similar features to protect the lender. For example, FHA loans have mortgage insurance premiums, or MIPs, which serve a similar purpose.
Private Mortgage Insurance Doesn’t Protect Borrowers
Private mortgage insurance is different from home insurance, flood insurance, or other types of insurance that are there to protect you. PMI’s only purpose is to protect your lender. If you experience financial hardship and can’t make your loan payments, PMI protects the lender so they don’t lose the money they loaned to you. It doesn’t offer you any foreclosure protections, payment deferrals, or financial assistance as a borrower.
How Much Does PMI Cost?
Like other types of insurance, PMI costs are based on risk. Loans that are considered more risky will have higher private mortgage insurance rates. If you are making a smaller down payment, your loan is considered more risky because you have less at stake than someone making a larger down payment. So a smaller down payment will cause a higher PMI cost.
PMI expenses are also affected by credit scores. If all borrowers have excellent credit, their PMI amount will likely be lower than borrowers with average credit if other aspects of the loan are the same. When calculating PMI for a loan with multiple borrowers, the lowest credit score is used.
It’s up to you to decide if the extra cost of private mortgage insurance is worth it compared to making a bigger down payment. If you want to purchase a home without a 20 percent down payment, the overall amount you spend on your loan could be higher. In addition to your PMI costs, a lower down payment will mean a larger loan with higher interest charges.
How Long Does PMI Last?
As long as you’ve been making payments on time for at least two years, you can typically ask for PMI to be cancelled once your loan-to-value ratio, or LTV, hits 80 percent, although you may have to pay for a new property appraisal.
If property values in your area have changed significantly since you took out your loan and you expect a new appraisal will show a much higher home value, you could consider asking to cancel PMI even sooner, although lender policies vary in this situation.
Royal provides all Members with a mortgage loan with an annual notice explaining their current loan-to-value ratio and their private mortgage insurance status. Members can always contact Royal for more information about cancelling PMI on their loan.
Loans subject to credit approval.