Becoming a homeowner is no easy accomplishment. It’s a major life decision, and knowing the ins and outs of the process is crucial to a successful outcome. If you’re interested in getting some financial help during this process, no doubt you have some questions. For example, what is PMI? How do you calculate the costs that will accompany your loan? And which option is the best fit for your financial needs?
While there’s no doubt that prospective homeowners will benefit from an expert opinion and consultation, cutting costs is a major focus at this time. Therefore, it’s best to learn all about these key points. This will allow you to shop for multiple options and do the math for each before diving in.
What Is Private Mortgage Insurance?
Of the crucial aspects behind buying a home, PMI is definitely worth considering. Just like the name suggests, it is a type of insurance, with the sole distinction being that it doesn’t actually serve to protect the interests of the one paying it. On the contrary, lenders (the companies that are approving and providing homeowner loans) use private mortgage insurance to back up the risk of the loan.
Generally, this insurance is issued by specific insurance companies for mortgages—i.e., the loans that are taken out with less than the standard 20% down payment. In other words, anyone interested in getting a loan to buy a residential unit of some kind will either need to put down this 20% minimum or, alternatively, pay private mortgage insurance along with the regular mortgage payment, fees, and more.
After all, the lender is the one risking more than 80% of the property’s value by approving your loan. With this in mind, said lender employs this type of insurance in case the leaser suddenly defaults on their mortgage’s monthly payments. If this happens, banks and lenders alike have estimated that they would only be able to get 80% of the property’s value at auction. So what is PMI insurance for them? It’s best described as a safety net for the remaining 20%, provided through payments by loan holders.
In this regard, it’s equally helpful to better understand and consider the implications of the loan-to-value ratio. As an amount, it represents the value of the loan divided by the full market value of the property. Hence, in a loan with a 10% down payment, the loan-to-value ratio is 90%.
Bear in mind that PMI mortgage payments depend on a range of factors. These include your credit score and any other loans, mortgages, or refinancing options you may have taken, as well as the consistency of your payments and your overall financial history and stability. The type of loan you’re applying for is another important tick on that list.
Conforming loans, otherwise known as conventional loans, that aren’t backed by any federal agencies seem to be a good option in today’s commercial society. PMI mortgage insurance costs solely apply for those putting less than 20% of their property’s value down. Applicants would likely pay higher insurance rates than, say, those going for an FHA loan.
While we’re on the matter, it’s useful to mention the loans backed by the federal government. One of the most popular instances is the loan backed by the Department of Veterans Affairs, which frees all applicants from both a down payment and PMI.
Meanwhile, an FHA loan is much more lenient in terms of the cost of mortgage insurance, as well as the down payment amounts. Backed by the Federal Housing Administration, this loan features lower premiums and more beneficial terms. However, a closer look reveals an up-front premium demanded as part of PMI. What’s more, the key advantage of regular conventional loans—being able to drop the PMI after your equity reaches more than 20%—is lost on these two alternatives.
How Does PMI Work?
If you’re off the idea of taking out a conventional loan, then there is much to be learned. The mortgage itself is a regular homeowner’s loan—taken out by prospective homeowners who have enough to cover a down payment but not enough to cover the rest of the house’s value. The bank, credit union, or other financial institution is here for that.
So what is mortgage insurance in relation to this? It’s a kind of safety net for the banks providing you with these massive amounts of money. As mentioned earlier, this type of insurance is activated when you’re looking to take out a conventional loan (one that isn’t supported by government offices) but you don’t have enough to cover a 20% down payment.
Before moving on to mortgage PMI in further detail, you should know that there are strict regulations determining the amount that your down payment will be. It isn’t solely up to the lender as to whether PMI will be incorporated into a client’s loan.
With the possibility of PMI’s misuse out of the way, individuals just need to follow the right steps, and they’ll be paying their monthly mortgage insurance from the comfort of their new home in no time. Put simply, all you have to do to get the process going is apply for a loan.
If you decide to put down less than 20% for your loan, the lender you’ve chosen will contact their own insurance providers and set up your PMI. At that time, you will be consulted and informed on the PMI payment options—the amount, schedule, and policies—and be able to choose based on your preferences.
In addition, your lender will inform you of the timespan during which you’ll be obligated to pay PMI, the specific reasons, the date at which your estimated equity should reach over 20%, and the terms thereafter. That way, you’ll be able to cut the PMI cost out of your monthly payments as soon as you meet the specific requirements.
Under normal terms, this happens when your mortgage balance reaches less than 80%, most often at 78%. Having passed that threshold allows you to set up a new appraisal of the house, which will confirm your home’s value and ultimately eliminate this specific PMI loan cost from your regular payments, fees, and additional charges.
Before we end the discussion on how to eliminate your PMI, be sure you consider the fluctuating prices of the real estate market, which can be used to your advantage. In other words, if the price of the property in your neighborhood goes up (due to numerous reasons), then you can have the house reappraised. Seeing more equity to your name is enough to get the real estate PMI cancelation process started. Even though you would have to do all the steps yourself, it will end up highly gratifying for your finances.
How Do I Pay for PMI?
Reaching that “promised land” of 20% or more is not easy work, and there are still plenty of aspects to consider even before you start making your payments. There are three private mortgage insurance payment options typically offered by lenders, with individuals choosing based on their financial power, as well as their personal preference.
Paying your PMI every month is one of the more commonly chosen options. Individuals are supposed to get a preview of payment details in their documents—the Loan Estimate and Closing Disclosure, right on the first page under Projected Payments. The latter section should also contain information on the mortgage insurance premium amount.
The prospective homeowner should also receive a detailed timetable, marking your payment due dates, the balance due according to the payment amounts, and the estimated time until PMI elimination.
Many interested applicants prefer having the matter handled as soon as possible, which is why they’re offered an up-front payment option at closing. Details of this type of PMI insurance would normally be found in the Loan Estimate and Closing Disclosure on page 2 of your loan documents, specifying the amount, terms, and any accompanying specifics.
In this line of thought, it’s best to consider any restrictions and requirements. After all, most of them won’t refund an up-front insurance premium if you move or refinance, severely affecting your overall financial plan.
A third option is paying a PMI percentage up-front, and then paying the rest on a monthly basis. In this case, the up-front charge is presented on page 2, section B of the Loan Estimate and Closing Disclosure, while the monthly charges are found in the same headings, on page 1. This one will offer a lower up-front charge than the previous one, and more or less the same goes for the monthly payments. Of course, there are plenty of factors at work here that need to be taken into account.
In the next section, we’ll answer the next big question, How is PMI calculated? But first, make sure to remember that a single lender may offer some or all of the options listed above. Shop for other options, ask around, and get estimates and offers everywhere you can in order to find the best mortgage for your needs. With real estate market prices skyrocketing, taking precautions and viewing all the angles is the least you can do.
How Much Is PMI?
The cost for the PMI you will need to pay, along with your mortgage and any other charges, is presented in the Loan Estimate and Closing Disclosure sections in your loan documents, as explained above. Make sure to check out the rates before closing the loan in order to avoid complications down the line. In this regard, it’s most helpful to know more about the actual PMI rates.
For mortgage loans taken out in the US, individuals are required to pay between 0.55% and 2.25% of the original loan amount. This range has been determined by the Genworth Mortgage Institute, Ginnie Mae, and the Urban Institute. However, when it comes to a particular mortgage lender, the situation varies depending on their own policies, as well as a number of additional elements. So how much is mortgage insurance going to cost most people? There are a few factors that are considered, so make sure to take them into account:
Each individual has their own credit score, determined based on their previous credit history. This includes any loans and/or debts that have been incurred in the past, the regularity of their payments, and their current status.
Amount of the Mortgage Loan
Mortgage insurance rates naturally depend on the amount you’re planning to take out in your loan. The greater the loan, the higher the rates, and vice versa.
Amount of the Loan Down Payment
Just as the amount of the loan affects the rates, so does the amount of your deposit, i.e., the mortgage down payment. The higher the payment, the lower the private mortgage insurance rates. After all, if you manage to start off with more equity in your name, you will be given lower, more benevolent rates.
Depending on whether you choose a fixed-rate or an adjustable-rate mortgage, your PMI will also have a different rate. Those with a fixed-rate mortgage pay less, while an adjustable rate produces higher PMI premiums due to the fluctuations.
A typical PMI rate offered by lending companies would be around 1%, although there are some that go as high as the max limit of 2.25%. Make sure to preview the rate calculations in your closing documents and determine if the numbers will be financially sustainable.
Just for the sake of better understanding the matter, let’s see how it would work in practice. Take an average PMI rate of 1% as the one offered by your lender. Next, let’s say that you are planning on purchasing a house worth $250,000 and have put a down payment of just 10% of the whole value, that is, $25,000. This means that your loan amount is $225,000. Calculate 1% of this amount, and you’ll get the annual charge that you will be obliged to pay—i.e., your PMI requirements. For the monthly premium, divide the last amount by 12.
For a better overview, see the example illustrated in the table below:
|Annual PMI Premium||$2,250|
|Monthly PMI Premium||$187.50|
On a final note, when calculating how much a PMI loan is going to cost you, taxes are an added consideration. Current PMI rates—the premiums that individuals pay—are no longer tax deductible. The last federal itemized tax deduction act expired on Dec. 31, 2017, and since then, such charges have not been deductible. A new House Bill has been underway since early 2019, but it hasn’t moved beyond the House Committee on Ways and Means. Should the bill pass, a tax deduction will become permanent for PMI premiums.
Is It Worth Getting a Loan That Requires PMI?
Whether it’s worth getting a loan requiring you to pay the cost of PMI as well as the mortgage payment can only be answered on a case-by-case basis. Each individual has a different financial standing, and there’s no way to generalize on who will be able to avoid it and who won’t.
Having said that, and understanding all the factors, costs, and tax charges related to PMI, it helps to know a few ways that you can get rid of your PMI rate early on—or avoid it altogether.
On the one hand, many lenders require PMI for loans taken out with down payments amounting to less than 20% of the home’s value. Quite simply, not all individuals are in a position to stall their homeownership process before saving enough for a higher down payment. Hence, those who can’t avoid it can learn about a few ways to cut it short:
Make Higher Monthly Mortgage Payments
If you make higher monthly mortgage payments, and pay higher PMI insurance premiums, you can reach 80% or less on your loan much faster. This way, not only will you be able to save yourself from PMI sooner, you’ll also pay less interest overall.
Check Your Equity’s Status
Even if you pay the regular amount, you may not notice when your equity has reached 20% or more. Therefore, make a habit out of checking this so you can avoid the extra charges.
Ask for a Home Appraisal
As mentioned above, if you think your home has increased in value, get the procedure started for a new appraisal. If it turns out to be worth more than the price at the time of purchase, you may come out ahead just enough to pass the 20% equity threshold.
As for those looking for no-PMI mortgage options, there are a few other tips to try:
100% Down Payment
There’s nothing better than paying the full price of your home up-front. Check your finances and calculate whether your salary range is sufficient to cover the expenses. If so, it’s the best way to avoid paying PMI charges, interest, and other accompanying fees.
20% Down Payment
A second option is reaching the 20% threshold before getting the loan. It’s worth the wait, as long as it’s doable, so it’s best to do the math and see where you come up if avoiding PMI is your goal.
Find a Government-Backed Loan
If you can’t raise 20% for the down payment and still want to avoid PMI, look for PMI-free loans. These include the ones mentioned above (VA and FHA), as well as some from commercial companies (Quicken Loans). Another option is an 80-10-10 loan, also known as the piggyback loan, where you only need 10% of the home price for the down payment.
Pay Higher Interest
Ultimately, some companies will make a deal with you and cut the PMI while imposing higher interest rates. In this case, calculate the costs of both plans and choose accordingly.
The matter of mortgage insurance has helped make many prospective homeowners’ dreams come true. However, things can get tricky if you aren’t being careful, or worse yet, if you aren’t fully aware of the implications that go along with PMI.
This text provides a comprehensive overview of the topic, along with the key features, factors, considerations, and guidelines. Nevertheless, as mentioned earlier, the situation changes per lender and individual, which is why it’s advisable to get a more personal approach. Most importantly, don’t move forward until you can answer the following: What is PMI? What costs does it incur? And what are the advantages and disadvantages?
Frequently Asked Questions
1. When can you stop paying PMI?
Only after your equity has reached 20% or more, that is, only after your total mortgage amount has reached 80% or less (normally 78%) will you be able to start the procedure of terminating your PMI premiums.
2. How can I avoid paying PMI?
There’s a whole list of guidelines on how to avoid PMI presented above, and many more if you are willing to do additional research into the matter. Generally speaking, though, the most viable ways to avoid it are by looking at a different set of loans (FHA, VA, 80-10-10) or by simply meeting the requirements for a conventional loan (20% down payment).
3. How do I get rid of PMI on my mortgage?
For people who want to pay their mortgages without PMI charges—even when they’re part of their loan plan—they’ll need to meet some requirements. The best way to get rid of these charges is to overpay your mortgage each month so that you reach the 20% threshold more quickly. You can also track your home value in case it increases, and then ask for a reappraisal.
4. Who pays for the PMI on a mortgage?
You will be in charge of covering the PMI insurance cost, along with the mortgage payments and other fees. After all, PMI is paid to protect the lender, since banks need the cushion in case you default on your loan.
5. How can I avoid PMI without 20% down?
This is best done by choosing a government-backed mortgage. For example, if you qualify for one of the loans offered by the Department of Veterans Affairs or the Department of Agriculture, you won’t even have to ask, What is PMI?