Private Mortgage Insurance, What You Need to Know

PMI is an insurance policy that protects lenders from losses if a borrower defaults on a loan. It is a type of insurance that is paid for by the borrower and is typically required when the borrower has less than a 20% down payment on a home. PMI premiums are usually paid in monthly installments and are added to the borrower’s monthly mortgage payment.

Purpose of PMI

The primary purpose of PMI is to protect lenders from losses caused by borrower default. By requiring borrowers to pay PMI, lenders can provide home loans to borrowers who may not otherwise qualify for a mortgage because they do not have a large down payment. PMI also allows lenders to offer borrowers lower interest rates, as the default risk is reduced.

When PMI is Required

Most lenders require PMI when a borrower’s down payment is less than 20% of the purchase price of the home. PMI is usually required for both fixed-rate and adjustable-rate mortgages. It is important to note that some lenders may not require PMI if the borrower has good credit and a large enough down payment.

How PMI is Calculated

The cost of PMI is based on a variety of factors, including the amount of the loan, the size of the down payment, and the borrower’s credit score. Generally, the higher the loan amount, the higher the PMI premium will be. 

The size of the down payment also affects the cost of PMI. Borrowers with a smaller down payment will typically pay higher PMI premiums than those with larger down payments. The borrower’s credit score is also factored into the PMI premium. Borrowers with higher credit scores are typically charged lower premiums than those with lower credit scores.

Advantages of PMI

PMI can be beneficial for some borrowers, as it allows them to purchase a home with a smaller down payment. This can make homeownership more affordable for borrowers who may not have the financial resources to make a larger down payment.

Disadvantages of PMI

The biggest disadvantage of PMI is the additional cost. The PMI premium is added to the monthly mortgage payment, which can make the loan more expensive. Additionally, PMI can take a long time to cancel, even after the borrower has built up equity in the home.

Examples of PMI Calculations

For example, a borrower with a $200,000 loan and a 10% down payment will typically pay an annual PMI premium of 0.5% to 1.5% of the loan amount. This would result in an annual PMI premium of $2,000 to $3,000. A borrower with a $200,000 loan and a 5% down payment, however, would typically pay an annual PMI premium of 1.5% to 2.5% of the loan amount, resulting in an annual PMI premium of $3,000 to $5,000.

PMI and Your Mortgage Payment

PMI is an added cost that can increase your monthly mortgage payment significantly. The amount of your monthly PMI payment will depend on the size of your loan, the size of your down payment, and your credit score. For example, if you have a $200,000 loan and a 10% down payment, your monthly PMI payment could be as much as $250. 

Fortunately, there are several ways to reduce or even eliminate the need for PMI. One way is to make a larger down payment on your home. The more money you put down, the less you will have to pay in PMI. Another option is to get a piggyback mortgage, which is a combination of two loans that allow you to avoid paying PMI.

Alternatives to PMI

Piggyback mortgages are an alternative to PMI that can help you avoid paying PMI premiums. With a piggyback mortgage, you get two loans instead of one—a traditional mortgage and a second loan for a percentage of the home’s purchase price. The second loan is typically for 10-20% of the purchase price and the two loans together make up the full purchase price.

Another option is to take advantage of homebuyer assistance programs. These programs are typically offered by state and local governments and can help qualified buyers purchase a home without having to pay PMI.

Cancelling PMI

Once you have reached certain milestones in your mortgage, you may be able to cancel your PMI. Generally, you must have at least 20% equity in your home and have made all of your payments on time for at least 12 months. Once you have reached these milestones, you can contact your lender and request to have your PMI canceled.

There are some potential drawbacks to canceling PMI. For example, if you have an adjustable-rate mortgage, canceling PMI could increase the risk of default if interest rates rise. Additionally, if you cancel PMI, you may lose the protection it provides in case of borrower default.

Conclusion

Private Mortgage Insurance (PMI) is an insurance policy that protects lenders if a borrower defaults on a home loan. It is usually required when a borrower makes a down payment of less than 20% of the home’s purchase price. The cost of PMI is based on a variety of factors, including the amount of the loan, the size of the down payment, and the borrower’s credit score. PMI is an added cost that can increase your monthly mortgage payment significantly. There are several ways to reduce or even eliminate the need for PMI, such as making a larger down payment or taking advantage of homebuyer assistance programs. Once you have reached certain milestones in your mortgage, you may be able to cancel your PMI. It is important for homebuyers to understand what PMI is and how it can affect their mortgage payments.

 

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