What is private mortgage insurance? Here’s what home buyers need to know

If you do a advance payment of less than 20% on your home, you will probably need to purchase private mortgage insurance. When you make a smaller down payment, lenders tend to consider you a more risky mortgage candidateand the PMI requirement protects your lender in the event that you do not repay your loan.

Although PMI allows prospective homeowners, especially first-time buyers, to qualify for a mortgage with less than a 20% discount, the monthly premium will add hundreds of dollars to your mortgage payment each month – so remember take this cost into account when you find out your budget for buying a home. PMI is required for conventional loans and FHA loans, but some types of loanssuch as VA loansdon’t ask for it.

Here’s everything you need to know about PMI, how it works, when you need it, and how much it will cost you throughout your mortgage.

What is PMI and how does it work?

PMI offers buyers the opportunity to purchase a home using a conventional mortgage loan with less than the required 20% down payment. PMI protects lenders who offer financing options with lower down payments. If you can’t make a down payment of 20%, your creditors consider you a riskier borrower with a better chance of not paying off your mortgage. If this happens, the lender could use the deposited PMI payments that you paid in default to recover part of your loss.

The price of PMI

PMI borrowers typically pay between 0.5% and 1.5% of the loan amount on average each year – or between $ 30 and $ 70 per month for $ 100,000 borrowed, according to Freddie Mac. For example, if you take out a $ 250,000 loan with a 5% down payment, PMI will add between $ 1,188 and $ 3,563 per year – or approximately $ 100 to $ 300 to your monthly mortgage.

How you pay PMI, whether monthly or annually, varies by lender. Some may also allow you to make a partial down payment on closing, which may reduce your monthly or annual PMI payments.

How to lock a low PMI rate

  • Credit rating: The higher yours credit ratingthe greater your chance of concluding a lower mortgage rate and PMI premium.
  • First payment: The closer you can get to a 20% down payment, the lower your PMI rate will be and the faster you can get rid of it.
  • employment: Ownership properties receive lower PMI rates than properties for rent or investment.

When can I stop paying PMI?

PMI is usually no longer required once you have at least 20% equity in your home – whether from paying off the principal or increasing the value of your home. In fact, your lender is required to cancel your PMI once your mortgage balance reaches 78% of the original purchase price of your home.

However, some lenders may have additional requirements that you must meet before fulfilling your PMI obligations. These may include making a number of mortgage payments, obtaining a new appraisal, or owing less than 80% of the principal amount of your loan.

Although this process may vary slightly depending on the lender, you can usually request a written cancellation of the PMI once you reach the 80% loan-to-value threshold. You must meet specific requirements set by the Consumer Financial Protection Bureau, including:

  • Record a good payment history
  • Current loan status (not default)
  • Equity should not be the subject of a subordinated loan
  • Proof of value if requested (obtained by valuation)

Borrowers with mortgages from Fannie Mae or Freddie Mac have a different threshold for removing the PMI if the mortgage is between two and five years. For these borrowers, the equity must be at least 25% before the PMI can be terminated.

The benefits of PMI

Although PMI adds extra cost to your monthly mortgage payments, in some cases it may be worth it. Here are some of the benefits of PMI:

  • You can buy a home earlier: For many potential homeowners, the high down payment requirements make owning a home seem unattainable. With an initial payment requirement of up to 3%, borrowers can buy a home earlier.
  • You can build wealth earlier: Owning a home can help you increase your net worth. Buying a home faster with PMI can also help you build equity faster, which in turn can help you eliminate PMI sooner.
  • This is only a temporary price: Once you reach the 80% LTV ratio (75% for Fannie Mae and Freddie Mac loans), you can request the removal of the PMI. If you do not request this, creditors are required to automatically remove the PMI when you reach 78% LTV.
  • PMI is currently deductible: If you file a detailed tax return, you can now deduct private mortgage insurance from your tax return until the end of 2021. This tax relief was resumed in the Supplementary Consolidated Appropriations Act, 2020 and extended until 2021 in the Consolidated Budget Appropriations Act. loans in January 2021.

Disadvantages of PMI

Although PMI can help you secure a mortgage with a lower down payment, there are some drawbacks to keep in mind.

  • This is an additional premium: No matter how low your PMI rate is, you will still pay extra costs each month.
  • PMI rates can be high: PMI rates are determined based on your credit rating, home employment, the amount of the initial payment and the increase in equity. A high PMI rate can increase your monthly mortgage payment by more than you can afford.
  • Canceling a PMI takes time: You still have to pay PMI until the lender cancels it at 78% LTV. When you request a cancellation earlier, you will often need to make a formal written request, which may take time to process and remove. You may also have to pay for an appraisal if your lender requires one.

Do all home loans require PMI?

Although PMI is usually only required for conventional mortgages, other specialized types of mortgages have their own version – with their own set of requirements.

  • Conventional mortgages: If you place less than 20% on a conventional loan, expect to pay PMI. There are some options that are not PMI, but they usually involve higher interest rates, which can actually cost you more in the long run.
  • FHA loans: FHA loans allow you to take a loan with only a 3.5% discount and have a monthly insurance premium or MIP. Depending on your lender, your MIP may require a down payment on completion and monthly or annual payments thereafter. Borrowers who make an initial payment of 10% or more must pay the MIP for 11 years, while borrowers who pay less than 10% must pay the PMI for the entire term of the loan.
  • USDA loans: Although USDA loans do not require advance payment, there is a requirement for mortgage insurance, with advance and annual fees attached. An advance fee of 1% of the loan value is due upon completion and annual fees of 0.35% per annum. Although USDA mortgage insurance cannot be revoked, it is usually more affordable than the FHA MIP and interest rates are usually lower.
  • VA loans: There is no mortgage insurance requirement for VA loans, but borrowers will have to pay a one-time initiation fee between 1.4 and 3.6%, depending on the amount of the initial payment. This fee can usually be included in the loan amount.
  • ARM loans: HAND, or adjustable rate mortgage, may also include PMI. The initial cost may be higher, but you may be able to build equity faster, allowing you to remove PMI faster than with a fixed rate mortgage.

Is PMI worth the cost?

There is a compromise here. PMI increases your monthly mortgage payment, but may allow you to buy a house with a lower down payment. With that in mind, you may be able to opt out of PMI if you receive a different type of loan, such as a USDA, VA, or a conventional non-PMI loan – or save on a larger down payment. If you decide to take the path of PMI, compare the rates for private mortgage insurance from different lenders before making a commitment.

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