All you need to know about Private Mortgage Insurance (PMI)

Buying a home is an important milestone in everyone’s life, however, there are several costs associated with a home purchase. One of the important expenses that you might need to pay for is mortgage insurance. Mortgage insurance is required by home buyers when they put a down payment of less than 20% of the home value. For example, on a $300,000 home, if your down payment is less than $60,000 ($300,000 x 20%), you will need to get mortgage insurance. 

Mortgage insurance is required by the lender because of the additional risk of lending you more money than 20% of the home value. The insurance protects the lender if the homeowner were to default on their payments. So, what are the costs, length of payment, and most importantly different types of mortgage insurance?

How much is Mortgage Insurance? 

The most common type of mortgage insurance is private mortgage insurance (PMI). PMI can range from 0.4% - 2.25% of the loan amount. For example, if you have a loan for $400,000, then PMI can range from $1,600 to $9,000. So, what determines whether you get a low PMI rate or a higher one: 

1. Loan Amount – A higher loan amount will require a higher PMI rate because of the additional risk to the lender. Therefore, a $700,000 mortgage will have a higher PMI than a $300,000 mortgage. 
2. Down Payment – Lenders prefer a higher down payment as it shows that the borrower has funds available to increase their homeownership. Higher down payment will result in a lower PMI rate.
3. Credit Score – Credit score is very important in all lending decisions; a higher credit score shows the lender that you are more credit-worthy and are more likely to pay back your debts. 
4. Mortgage Type – PMI rate is higher for adjustable-rate mortgages as compared to fixed-rate mortgages because of the uncertainty regarding the size of the monthly mortgage payment.

How long do I have to pay for Mortgage Insurance?

Mortgage insurance is required for home loans where the down payment is less than 20% of the loan. Therefore, PMI can be canceled when you attain 20% homeownership. Hence, insurance does not stay for the life of the loan, it can be removed on average in 6 years depending on the size of the initial down payment. 

What are the different types of Mortgage Insurance?

There are four different types of mortgage insurance: 

1. Borrower-Paid Mortgage Insurance (BPMI) – this is the most common type of insurance. In this form of insurance, the premium is added to your monthly mortgage payment making it higher every month. Once you reach 20% homeownership you can reach out to the lender and cancel it. You can also get rid of PMI if you refinance and have a smaller loan amount.

2. Single-Premium Mortgage Insurance (SPMI) – in this form of insurance rather than increasing your monthly mortgage payment, the insurance is paid upfront in a lump-sum amount. This can be a good strategy if you want smaller monthly mortgage payments. However, these funds can also go towards increasing your down payment. 

3. Lender-Paid Mortgage Insurance (LPMI) – now, although this one sounds great that the lender pays for insurance, the payment is eventually passed on to you in the form of a higher mortgage rate. Therefore, if you choose this option you will pay higher interest over the life of the loan instead of paying for PMI. Over time this option becomes detrimental as compared to the other options, hence, it is advisable to not pick this option.  

4. Split-Premium Mortgage Insurance – this type of insurance is a combination of BPMI and SPMI, where instead of adding the entire amount to your monthly mortgage payment, you pay some of it upfront and the rest gets added to your mortgage payment. This way you do not need a very large upfront payment and your mortgage is manageable. 

How to avoid Private Mortgage Insurance?

Well this is an important question, nobody wants to pay for insurance if it does not benefit them. There are 3 ways to not pay for insurance:

1. Down payment greater than 20% - well, this one is straightforward, a larger down payment could mean no PMI, therefore, if you can borrow funds or save up for longer that can help you avoid PMI.
2. USDA Loans – USDA loan is a government insured loan that does not require PMI. Instead it has other rules and eligibility that need to be met. 
3. VA Loans – VA Loans is a mortgage targeted at veterans, therefore, if you are a veteran you can get a VA loan without needing PMI!

In conclusion, insurance can be an annoying additional payment that you have to make, however, it is useful because it allows lenders to give mortgages to individuals who cannot afford the full 20% down payment. Try your best to save up enough funds in order to avoid paying mortgage insurance. Most importantly, be sure to get rid of PMI when you attain 20% homeownership!