Private Mortgage Insurance (PMI) is a type of Insurance policy that protects lenders against financial loss in the event borrowers default on their mortgage. Borrowers pay the monthly premium to the insurer and the coverage will pay a portion of the balance due to the mortgage lenders in the event they default on the home loan. Mortgage Insurance lowers the risk to the lenders of making the loan and borrowers can qualify for a loan that they might not otherwise be able to get.
Private Mortgage Insurance (PMI) is usually required on Conventional Mortgage Loans if the borrowers can’t make at least 20% down payments. Unlike homeowners insurance, Private Mortgage Insurance (PMI) does not protect the home, it only pays losses to lenders if they default on their Mortgage. The “Private” in PMI means that it is offered by privately owned companies and not by the Government. The Private Mortgage Insurance (PMI) is usually included in the Monthly Payments. PMI can be removed once a borrower pays down enough of the Mortgage’s Principal.
The Private Mortgage Insurance (PMI) for FHA Loans backed by the Federal Housing Administration, operates a little differently from PMI for Conventional Mortgage Loans. VA Loans are backed by the U.S. Department of Veterans Affairs which doesn’t require Private Mortgage Insurance (PMI) but includes the funding fees. USDA Mortgage Loans are backed by the U.S. Department of Agriculture which have upfront and annual fees. There are several different kinds of loans available to borrowers with Low Down Payments. Depending upon what kind of loan the borrower gets, they have to pay for Private Mortgage Insurance (PMI) in different ways.
What Is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance (PMI) is the extra monthly fee that protects lenders in case the borrowers can’t afford their mortgage payments. In many cases, Private Mortgage Insurance (PMI) is no longer required once the borrower has made enough timely mortgage payments including the borrower has sufficient equity in the property. Private Mortgage Insurance (PMI) only applies to conventional mortgage loans, which follow Fannie Mae and Freddie Mac’s guidelines. The Private Mortgage Insurance (PMI) fees go towards insurance coverage that protects the lenders, not the borrowers in case the borrowers can’t make the monthly payments and default on their loans.
How Does Private Mortgage Insurance (PMI) Work?
Private Mortgage Insurance (PMI) is a lot like the insurance policy where the borrowers make payments every month for the coverage. But remember Private Mortgage Insurance (PMI) only protects lenders, not homeowners. One of the measures of risk that lenders use in underwriting a mortgage loan’s the loan-to-value ratio (LTV). The LTV is the ratio of the amount of loan to the value of the Home. Most Mortgages with an LTV ratio greater than 80% require that the borrowers have PMI as they are considered more likely to default on the loan. Private Mortgage Insurance (PMI) is usually paid monthly as a part of the overall mortgage payments to the lenders, however, sometimes it is paid as a one-time, upfront premium at closing. Once Private Mortgage Insurance (PMI) is required, a Mortgage Lender will arrange it through their own Insurance providers.
What Are the Types of Private Mortgage Insurance (PMI)?
Four main types of Private Mortgage Insurance (PMI) might come across during the process of getting a mortgage loan.
- Borrower Paid Private Mortgage Insurance (PMI): It is the most common type of Private Mortgage Insurance (PMI), which involves the lender adding a monthly premium to Mortgage Payments.
- Lender-Paid Private Mortgage Insurance (PMI): In this PMI, the Lenders pay for Homebuyer’s mortgage insurance coverage with a lump sum when they close on the home. In return, they have to pay the higher interest rate on their loan.
- Borrower-Paid Private Mortgage Insurance (PMI): This PMI is similar to Lener-Paid PMI, the borrower-paid approach involves making the lump sum payment made upfront at closing. But in this case, the payment is made by the buyers.
- Split-Premium Private Mortgage Insurance (PMI): This PMI allows homeowners to pay a Portion of the PMI premium upfront, resulting in lower monthly premiums moving forward.
How Much Does Private Mortgage Insurance (PMI) Costs?
The Average annual costs of Private Mortgage Insurance (PMI) typically range from 0.58% to 1.86% of the original loan amount, depending on the borrower’s credit score, according to an analysis by the Urban Institute. However, the Costs of Private Mortgage Insurance (PMI) depends upon the following Factors:
- Size of Mortgage Loan: The More money homebuyers borrow the more they will pay for Private Mortgage Insurance (PMI).
- Down Payment Amount: The More Money homebuyers put down for the home, the less they pay for Private Mortgage Insurance (PMI).
- Credit Score: The Private Mortgage Insurance (PMI) costs will be less if the borrowers have higher credit scores. Generally, homebuyers will see the Lowest Private Mortgage Insurance (PMI) rates for credit scores of 760 or above.
- Type of Mortgage: The Private Mortgage Insurance (PMI) costs will be higher for adjustable-rate mortgage loans than the fixed-rate mortgage loans. Because the rates can go up with the Adjustable-rate mortgage and the loan is riskier than the fixed-rate mortgage, so Private Mortgage Insurance (PMI) is likely higher.
How To Calculate Private Mortgage Insurance (PMI)?
To Calculate the Private Mortgage Insurance (PMI), borrowers need to ask their lenders for the Private Mortgage Insurance (PMI) percentage and then follow these process:
- Identify the Property Value: Borrowers can get the exact figure from a recent appraisal or estimate it by using the amount they plan to offer for the house.
- Find out the total loan amount: To estimate the Private Mortgage Insurance (PMI) for a refinance, borrowers have to start with their current mortgage balance.
- Calculate the LTV: Divide the loan amount by property value and then multiply by 100 to get the percentage. If the result is 80% or lower, then Private Mortgage Insurance (PMI) is 0% means the borrowers don’t have to pay Private Mortgage Insurance (PMI). if it is higher than 80% then move on next step.
- Estimate Annual Private Mortgage Insurance (PMI) Premium: Take the Private Mortgage Insurance (PMI) that is provided by the lender and multiply it by the total loan amount. In case the Private Mortgage Insurance (PMI) Percentage is not understood, calculate for the high and low ends of the standard range. Now, use 0.22% to figure out the low end and use 2.25% to calculate the high end of the range. The result is an annual premium. To estimate the monthly premium, divide the result by 12.
- Homeowners can also use any online mortgage calculator to calculate the Private Mortgage Insurance (PMI) Premium.
How to Make Private Mortgage Insurance (PMI) Payments?
There are three main ways to make Private Mortgage Insurance (PMI) Payments. It includes:
- Monthly: It is the most common method of paying Private Mortgage Insurance (PMI) monthly with a Mortgage Payment. This boosts the size of the monthly bill, which allows homebuyers to spread out the premiums over the course of the year.
- Upfront: Another Method of Paying Private Mortgage Insurance (PMI) is an Upfront PMI Payment, which means the homebuyers pay the full premium amount for the year all at once. The eligible borrower’s monthly mortgage payments will be lower, however, they need to be ready for those larger annual expenses.
- Hybrid: The third option of Paying Private Mortgage Insurance (PMI) is a hybrid one. This method can be useful if homebuyers have extra cash early in the year and want to lower their monthly housing costs.
Pros and Cons of Paying the Private Mortgage Insurance (PMI)
Paying PMI comes with one major benefit and it enables the borrowers to buy homes without waiting until homebuyers can afford a 20% Down Payment. Here are some of the Pros and Cons of Paying the Private Mortgage Insurance (PMI)
Pros:
- Paying Private Mortgage Insurance (PMI) makes the homes with less than 20% possible.
- May be tax-deductible.
- Can be removed once homebuyers have 20% equity in their home.
Cons:
- Private Mortgage Insurance (PMI) does not provide any protection for the Homeowners.
- Too costly for borrowers with low credit scores.
- It may increase the monthly payments or upfront costs.
Frequently Asked Questions (FAQs)
Question 1: How to Avoid Paying Private Mortgage Insurance (PMI)?
Answer: If the don’t have funds for the 20% Down Payments, then it is possible to avoid Private Mortgage Insurance (PMI) by taking two loans such as smaller loans to cover the amount of the 20% down, plus the main mortgage.
Question 2: Is Private Mortgage Insurance (PMI) Good or Bad?
Answer: Paying Private Mortgage Insurance (PMI) adds to the homebuyer’s monthly mortgage payments, however it does not have any negative effects beyond costing some extra cash.
Question 3: Does Private Mortgage Insurance (PMI) decrease over time?
Answer: No, Private Mortgage Insurance (PMI) does not decrease over time. However, if the borrowers have a conventional mortgage loan then they will be able to cancel once their mortgage balance is equal to 80% of the home’s value at the time of purchase.
Question 4: Is Private Mortgage Insurance (PMI) automatically removed at 20%?
Answer: For many mortgages, Borrowers can request PMI be removed after they have paid enough so that they have 20% equity in their home. Lenders will automatically remove PMI when they have a Loan-to-value ratio of 78%, or have 22% equity in their home.
The Bottom Lines
Private Mortgage Insurance (PMI) is the extra expense that allows homebuyers to purchase a home without making a significant down payment, which means they might well become a homeowner sooner. Private Mortgage Insurance (PMI) can be a costly necessity for homebuyers who don’t have enough money saved for a 20% down payment. It may be possible to avoid Private Mortgage Insurance (PMI) by taking out the main mortgage plus a smaller loan to cover the costs of a 20% down payment.
