If you are looking to buy a home but are putting in less than a 20% down payment, you'll likely be paying PMI or Private Mortgage Insurance. PMI is an insurance policy for the lender in case you stop making your monthly payments. Depending on your LTV (loan to value) ratio and other factors, your PMI cost may vary. On average, PMI for a conventional home loan ranges from 0.58% to 1.86% of the original loan amount per year. Below is a guide on PMI, how much PMI is, and other facts you should know before paying PMI.
How Much Is PMI?
What Is PMI?
As stated above, PMI is essentially an additional payment as part of your mortgage that acts as insurance for the lender of a mortgage if the borrower stops paying back their loan. You'll only have PMI to pay if you put a down payment of less than 20% on your home. You can request to have the PMI portion of your mortgage payment canceled once you've reached the 20% equity in your home, but the lender is not required to do so, making it that much more important to get to the 20% initially. Typically, PMI is automatically canceled once you reach 22% equity in your home, though.
PMI also only applies to conventional loans. Other loans types will have their versions of insurance for the lender, but they can work differently from PMI.
When Is PMI Required?
PMI may be required when you're purchasing a house or refinancing your mortgage. In addition, lenders may require PMI on certain loans if:
Your down payment is less than 20%: Most conventional lenders require a down payment of at least 20% of the purchase price. Therefore, you may have to pay for PMI when buying a home with a downpayment of less than 20% of the purchase price.
For refinance loans: Your loan-to-value ratio is over 80%. If you're refinancing your current mortgage, most conventional lenders require an LTV ratio of 80% or less to avoid paying PMI. If your LTV is over 80%, you may need to pay PMI.
Who Provides PMI?
If you do need to pay PMI, your lender, not you, will choose the provider of the PMI. In most cases, you won't know the provider as you make the payment directly to your lender, and they will pass the PMI portion along to the PMI provider. As a result, PMI rates may vary depending on your lender, their provider, mortgage types, and PMI types listed above.
When Do You Pay PMI?
PMI payments can be paid in a few ways depending on PMI type (more on that below). Your lender may let you choose how you pay your PMI, and others will make that decision for you. The most common PMI payment methods include:
- Monthly Premium: The most common PMI option is to have an additional charge each month with your mortgage payment. When paying a monthly premium, our lender adds PMI to your monthly mortgage payment.
- Upfront Premium: Instead of a monthly premium, another option is to pay the entirety of your PMI upfront at closing. It's a higher cost upfront, but you'll have a lower monthly mortgage payment moving forward.
- Monthly and Upfront Premiums: The last option is a combination of the previous two. In this case, you'd pay part of the PMI upfront and then add a smaller monthly premium to your mortgage payment.
Types of Private Mortgage Insurance (PMI)
When paying PMI, there are several ways you can do it. Below are five types of PMI you might encounter.
Borrower-Paid Mortgage Insurance
Borrower-Paid Mortgage Insurance (BPMI) is the most common type of PMI. BPMI is an extra payment you make each month in addition to your regular mortgage payment. You can request to have the BPMI payment canceled once you've hit the 20% equity mark, but lenders are not required to agree to do so. Typically, once you have 22% equity in your home (based on the original purchase price), your BPMI will then be canceled, and you'll only pay the regular mortgage payment each month. In both cases, you'll need to be current on your mortgage payments.
Depending on how far below the 20% equity threshold will determine how long you will be paying PMI, remember that in the beginning, most of your mortgage payments are going toward interest. Reaching the 20% or 22% marks could take several years.
Single-Premium Mortgage Insurance
Single-premium mortgage insurance (SPMI) works a little differently than BPMI. With SPMI, the borrower pays the entirety of the PMI payment upfront. SPMI can be paid either in full at closing or financed into the mortgage.
The benefit of SPMI is that you keep a lower monthly mortgage payment which could help you qualify to borrow more to buy your home. However, once you have paid the SPMI, there is no way to recoup the cost, even if you sell or refinance your home in a few years. For example, if you are buying a starter home and plan on moving to a bigger house in a few years, SPMI is not the right move for you. At the same time, if you plan on staying in your home and you've lumped the SPMI into your mortgage, you'll technically be paying interest on the SPMI as well, so there are risks on both sides.
The exact terms of the SPMI and who is responsible for paying it can be negotiated. Still, because of its risks, many lenders don't offer it to potential buyers.
Lender-Paid Mortgage Insurance
With lender-paid mortgage insurance (LPMI), technically, the lender will pay the mortgage insurance premium. However, you will pay for the PMI during the mortgage repayment in the form of a slightly higher interest rate. Because you pay the PMI in the form of a higher interest rate, reaching the equity threshold of 20% or 22% won't change your payment or make you eligible to cancel the PMI. The only to “remove” the PMI with LPMI is to refinance your home once you've reached the required equity in your home. Like SPMI, once the PMI is paid, it's paid; there is no getting your money back.
The benefit of lender-paid PMI, despite the higher interest rate, is that your monthly payment could still be lower than making monthly PMI payments. That way, you could qualify to borrow more.
Split-Premium Mortgage Insurance
Another form of PMI is Split-premium mortgage insurance, but it is the least common form of PMI. The best way to describe Split Premium PMI is a combination of BPMI and SPMI. With Split PMI, you'd pay part of the PMI as a lump sum at closing (like SPMI) and the rest as a regular monthly payment as with BPMI. With split payment, you have the benefit of less money needed at closing and lower monthly payments moving forward. The monthly premium will be based on the net loan-to-value ratio before any financed premium is factored in. With Split PMI, you can have the ongoing payments canceled once you reach the required equity.
Federal Home Loan Mortgage Protection (MIP)
Not technically a form of PMI, but still worth noting as it has the same principles. Federal Home Loan Mortage Protection, or MIP, is only applicable if you use the Federal Housing Administration (FHA) to buy your home. MIP is only required if the down payment on a home is 10% or less. MIP cannot be canceled due to refinancing, and buyers will need to wait at least 11 years to cancel MIP payments.
Furthermore, it cannot be removed without refinancing the home. MIP requires an upfront payment and monthly premiums (usually added to the monthly mortgage note). The buyer must still wait 11 years before removing the MIP from the loan if they had a down payment of less than 10%.
How To Calculate Your PMI Cost
The first step in calculating PMI is to determine if you'll need to pay it in the first place. Take your down payment, divide it by the home's purchase price, then multiply by 100. If you wind up with a number below 20, then you'll likely need to pay PMI. For example, if you have a down payment of 20k ready for a home that will cost 150k:
20,000 / 150,000 = .13333333
.133333 * 100 = 13.333
That means you'll have a 13.33% down payment and would likely need to pay PMI.
Once you've determined if you'll need to pay PMI or not, you can start to determine how much your PMI payment could be. You likely won't have exact numbers for many of these factors, but you can use estimates to have an idea of how much you might pay. More than likely, it's easier to use an online calculator, like this one.
The calculator estimates the total amount you'll pay for mortgage insurance until you have 20% equity and can get rid of PMI.
Here is what you'll need. Again, you'll likely need to estimate some numbers here:
- Your Home's Purchase Price: This can be the price you've been approved for, are aiming to pay, or have already agreed to pay.
- Down Payment: How much cash are you putting toward your home up front.
- Interest Rate: If you already have an interest rate locked in, enter that. Otherwise, you can find the average interest rates here.
- Mortgage Insurance Rate: You can ask your lender what their PMI provider's rates typically are. You can also choose a value within the typical range of 0.58% to 1.86%.
- Loan Term: This is typically 30 years for first-time home buyers. The other most common term is 15 years, but this is more common for refinances.
With that information, you should be able to get an idea of how much you'll be paying in PMI from any calculator you find online.
Other Factors for PMI
The factors above will generally give you a good idea of how much PMI you'll be paying for any particular situation. Still, other factors can affect your PMI payment amount as well.
As with any loan, your credit history/credit score will come into play. Remember, PMI is insurance for the lender in case you can't pay the loan back. By looking at your credit score, a lender can see how well you've been able to pay back loans in the past. A higher credit score will show the lender that you've been responsible with loans, paying bills, and not taking on too much debt and can therefore be trusted to pay back the mortgage with higher confidence. If that is the case, you may pay a lower rate on your PMI.
Fixed-Rate vs. ARM
There are typically two types of mortgages regarding the interest rate: fixed-rates loans and Adjustable Rate Mortgages (ARM). Depending on which one you use for your home purchase can change your PMI rate as well.
With fixed-rate mortgages, once your interest rate is determined, it cannot change. This gives the borrower a steady payment amount no matter what happens to interest rates in the future. This can be seen as less risky to lenders, so their PMI rate may be lower for a fixed-rate loan.
ARMs are a little harder to predict. They can be seen as more or less risky depending on the lender. On the one hand, the interest rates typically start lower than fixed-rate mortgages making it easier and faster for a borrower to gain enough equity in their home to cancel the PMI payment.
On the other hand, with the possibility of rates shooting up and having a borrower no longer able to afford the payments, they can be seen as more of a risk to other lenders, therefore giving borrowers a higher PMI rate for ARMs.
How To Avoid Paying PMI
The goal would be to avoid paying any PMI altogether. Luckily, doing so is relatively simple.
Have a Down Payment of 20% or More Ready
The most clear-cut and straightforward way to avoid paying PMI is to have a 20% down payment for your home ready to go from day 1. Remember to take the market conditions into account before bidding on a home. If it's a seller's market, you'll likely need to come in over the asking price, and that 20% number can rise quickly. Be sure to leave yourself some wiggle room and don't overreach.
In some cases, lenders will offer to waive PMI even if you don't have a 20% downpayment. However, the trade-off is that you'll have a higher interest rate on your mortgage. Make sure the math makes sense. Remember, you can eventually remove PMI, but the interest rate is likely locked for the entirety of the loan unless you refinance down the road.
Pay Down Your Current Mortgage
If you're looking to refinance, make sure you have 20% equity in your home first. By keeping the LTV at the right level, you'll be able to avoid PMI on the refinanced mortgage. Don't rush into refinancing because the interest rates are reasonable. They typically don't jump up fast enough to warrant adding PMI to any mortgage.
Use a Piggyback Loan
A piggyback loan is much more unconventional than the other methods of avoiding PMI. Still, in some cases, it can work out. Let's say you put down 10% on your home. You'd then take out a second mortgage, typically in the form of a home equity line of credit (HELOC), to cover the rest of the downpayment, bringing you to 20%.
When you do this, you'll avoid paying PMI, but now you'll have two different loans to pay back, with two different interest rates. HELOC's tend to have higher rates as well, so you'll need to do the math to make sure that even with the higher rate, the payments you'll be making are less than if you have a PMI payment to make.
How To Get Rid of Your PMI Payment
If you are currently making PMI payments, you have a few ways to get rid of them. Once you reach any of the equity requirements, you'll need to request your mortgage provider to cancel the PMI payments via, this is not a typo, writing them a letter. They certainly don't make it easy, do they? Here are the requirements you'll need to reach to complete your request:
- Reaching 20% equity in your home – in this case, the payments do not have to be removed; you can only request that they are.
- Reaching 22% equity in your home – in this case, the payments are typically automatically canceled; if not, make a request.
- Your home value has increased enough where you'd have 20% equity or more – This can be due to improvements you've made to your home or due to market conditions raising the value of your home. In either case, you'll your home appraise to prove its value on the open market.
- Refinancing – If you refinance your home with an LTV of 80% or less, you'll avoid paying PMI on the new loan.
For the best chances to have your request to cancel mortgage insurance approved, you'll need to be up to date with current mortgage payments, with a good history of paying on time, and have an appraisal done on your home to prove further you've passed the equity requirements. Make no mistakes. Getting PMI payments removed as quickly as possible is very important. For one, that is less of a monthly payment you'll have. Two, if you are used to making that payment, you can apply that toward your mortgage to help pay it off years faster, saving thousands of dollars in interest.
There is a lot that goes into PMI. Nobody wants to add additional payments to their mortgage, but it may or may not be the better option depending on your financial situation. In most cases, avoiding PMI by reaching the 20% down payment threshold is best, but that's not always possible. With any payment or loan, you'll have different options when it comes to getting rid of the pesky PMI payment as well. Make sure you consider all factors and choices whenever you're making a real estate purchase, real estate investment, or refinancing a current mortgage.
This post originally appeared on Wealth of Geeks.