Lenders are in business to make money. Lenders want to ensure they create loans at the lowest risk possible. For most, lenders are comfortable with a 20% down payment. Anything below this may require private mortgage insurance (PMI) to cover the risk that is associated with the loan.
In this article we will cover the following topics:
- What is Private Mortgage Insurance?
- When is Private Mortgage Insurance Needed?
- Types of Private Mortgage Insurance
- 1 – Borrower Paid Mortgage Insurance (BPMI)
- 2 – Single-Premium Mortgage Insurance (SPMI)
- 3 – Lender Paid Mortgage Insurance (LPMI)
- The Cost of Private Mortgage Insurance
- Ways to Avoid Paying Private Mortgage Insurance
- 1 – Make Down Payment of 20%
- 2 – Take a Piggyback Loan
- 3 – Refinance Your Mortgage
- 4 – Cancel PMI Later
- 5 – Veteran Exemptions
- 6 – Consider other Alternative Loans
- 7 – Do Adequate Research
- FHA Mortgage Research
- Final Thoughts
What is Private Mortgage Insurance?
Are you new into real estate and wondering what is private mortgage insurance? Well, private mortgage insurance or PMI is a form of mortgage insurance that is required if you are refinancing with a conventional loan or when you want to make a down payment that is less than 20 percent of the home’s value.
When you are buying a home with a down payment of less than 20% percent, the lender will require PMI coverage when giving you a conventional home loan. Although the homeowner is required to part with a hefty premium, this type of mortgage insurance doesn’t cover them.
Instead, it aims at protecting the mortgage lender when a homeowner defaults from making their mortgage payments as this makes them lose on the sale. If the lender forecloses on the home and is not able to regain the balance, the private mortgage insurance will help pay out the difference.
When is Private
Mortgage Insurance Needed?
Lenders require PMI coverage when there are higher chances of the borrower defaulting on the loan. Lenders use mortgage calculators to evaluate the loan to value ratio to determine if the borrower needs to pay PMI.
During the loan application process, you will come across the loan to value (LTV) ratio. The LTV ratio is gotten by dividing the amount of mortgage by the value of the home. When the Loan to value is more than 80%, then PMI coverage is needed.
For instance, is the mortgage amount is $90,000 and the home value $100,000; the PMI will be 90% (100,000/90,000). If your home value is $200,000 and the mortgage is $150,000, the loan to value ratio is 75%. In this case, PMI coverage won’t be needed.
The lender may also require private mortgage insurance after evaluating factors such as poor credit score and past foreclosures. A higher credit score may attract a lower PMI rate as this convinces the lender that you can make on-time debt payments.
Types of Private Mortgage Insurance
There are three basic types of PMI payments that you should familiarize yourself with before taking a mortgage.
1. Borrower Paid Mortgage Insurance (BPMI)
This is the most common type of PMI that includes rolling out a monthly fee that you pay together with your mortgage payment. Most borrowers use this method to make their PMI monthly payments.
As long as your mortgage payments are current, the lender will cancel your borrower-paid mortgage insurance (BPMI) when the equity in your home reaches 22%. Also, a borrower that has attained 20% equity in their home can request the lender to cancel the BPMI payment.
2. Single-Premium Mortgage Insurance (SPMI)
This is another type of mortgage insurance where the borrower makes an upfront lump-sum payment for mortgage insurance. The payment can be financed into the mortgage or made in full at closing. Unlike the BPMI, the monthly payment of the single premium mortgage insurance is significantly lower.
3. Lender Paid Mortgage Insurance (LPMI)
With this type of mortgage insurance, the lender pays the mortgage insurance premium on your behalf. It is also a good option if you are looking to lower your monthly payments through refinancing.
Although this mortgage insurance type has a higher interest rate, it has lower monthly payments. This, therefore, means that you are eligible to borrow more. However, the interest rate stops declining once you have reached 20% or 22% equity.
The Cost of Private Mortgage Insurance
Usually, the PMI costs between 0.5%-1percent of the total annual mortgage loan amount. So if you were to take a $300,000 loan with PMI fee of 1%, the total cost of PMI for the year would be $3000 or $250 each month.
The cost of PMI is often included in the monthly mortgage payments of the borrower. It is always wise to use a mortgage calculator if you have questions on what is private mortgage insurance for your loan.
The cost of PMI can also depend on several factors such as:
- Your credit score- the lower the credit score, the higher the mortgage insurance premium.
- The loan term
- Loan to ratio value
- Whether the interest is fixed or adjustable
- Your premium plan
Ways to Avoid Paying
Private Mortgage Insurance
Although private mortgage insurance can help you be eligible for a loan that you would otherwise not be able to get, it is likely to increase the cost of your loan. The high cost of PMI is enough reason to avoid taking PMI. While lenders require it to protect themselves, it is an expense for the borrower. Luckily, there are ways for a borrower to avoid PMI.
1. Make Down Payment of 20%
With a down payment of at least 20 percent, you will avoid conventional loans that carry PMI. Therefore, one way to avoid paying PMI is by ensuring that your loan to value ratio is 80 percent or less. The loan to value ratio is the amount of home loan compared to the value of the home. What’s more, a 20 percent down payment can see you receive a lower interest rate.
2. Take a Piggyback Loan
If you do not have the fund to make a down payment of 20%, you can opt to take two loans to avoid PMI. In this method, the borrower takes a second mortgage to cover a part of the down payment to get rid of the PMI requirement. This loan is also known as the 80 / 10/ 10 that comprises of the 80 percent first mortgage, 10 percent down payment, and 10 percent second mortgage.
For instance, if you buy a home for $300,000 and only have enough to make a 15% down payment, it is not wise to take a mortgage to cover the remaining 85 percent of the purchase price. Instead, you can obtain a 70% mortgage of the total value of your property and a second mortgage to cover the balance of 15%.
From the example above, the piggyback mortgage can help you avoid the PMI. However, it has a drawback of having high-interest rates.
3. Refinance Your Mortgage
Another option is to refinance your loan. This can help you if you have a conventional loan that needs you to carry PMI until the loan-to-value ratio reaches 80%. When refinancing your mortgage, do extensive research to ensure that the new loan doesn’t cost much in the long run.
4. Cancel PMI Later
If you already have private mortgage insurance, it is wise to monitor the loan to value ratio. According to the Homeowners Protection Act (HPA), PMI needs to end once your loan’s balance reaches 80% of your home’s original value. Also, keep track of the home prices in your area.
This is because when your home’s market value increases, you will no longer be obliged to pay PMI. When this happens, contact your lender to terminate the PMI. While you may spend some bucks to get this done, it will save you a lot more in the long run.
5. Veteran Exemptions
If you are a veteran, you could opt for a VA loan which is exempted from PMI. VA is a type of home loan given to veterans by private lenders. A VA loan does not require a down payment and you will not pay mortgage insurance fees. Reach out to your lender to inquire about the VA loan.
6. Consider other Alternate Loans
If you need money to buy a home, you can look at other alternative other than conventional loans that carry PMI. There are numerous types of home loans like the Federal Housing Administration (FHA) Loans that can be a good option. An FHA loan is insured by the Federal Housing Administration and have a down payment that ranges between 3-5%. Just make sure that you choose the best loan for your situation.
7. Do Adequate Research
It pays to do your research and find out what is private mortgage insurance of different lenders. You will be surprised to find out that there are lenders that offer mortgage products without needing PMI. Do not settle for a mortgage without first comparing the offers from different mortgage lenders. Otherwise, you might end up with an offer that requires you to pay higher mortgage insurance and interest.
FHA Mortgage Insurance
There are numerous differences between private mortgage insurance and FHA mortgage insurance. With FHA mortgages, the borrower is required to pay monthly mortgage insurance that ranges from 0.45% to 1.05% of the loan amount. The premium is based on the down payment as well as the loan term.
Compared to PMI, FHA mortgage insurance also requires that the borrower pays an up-front premium. Additionally, borrowers with a low credit score are eligible for an FHA loan which is not the case with conventional loans.
Final Thoughts on What is Private Mortgage Insurance?
Private mortgage insurance is a quick way to become a homeowner; however, it can contribute to your monthly mortgage expenses. If you place a down payment of less than 20% percent of the purchase price, you will pay private mortgage insurance and high monthly payments.
Luckily, there are numerous ways to avoid PMI including taking the main mortgage and a small loan to cover the 20 percent. You can also have the PMI canceled once you attain 20% percent equity in your home. Do not hesitate to ask your lender what is private mortgage insurance before taking an offer.