Real Estate Marketing & Beyond
Private mortgage insurance (PMI) might sound like something that will protect you if you can’t make a mortgage payment. There is some limited truth to that but mostly PMI is something that you pay as a homebuyer, but is for the benefit of your lender. PMI is almost always required when you take out a conventional loan with a down payment that is less than 20% of the purchase price. PMI is also typically required if you refinance your home with a conventional mortgage and have less than 20% equity in your home after the refinance. This is where the infamous and theoretical 20% required down payment comes from. If you have at least 20% equity when taking out a conventional loan, you can generally avoid paying PMI.
Your cost for PMI will be a percentage of the loan amount but will vary depending on your credit score and amount of down payment. Generally, you will pay between 0.3% to 1.5 % of the loan amount each year. This fee goes to a private insurance company and is in addition to the interest rate that you pay to the lender. So, you if your loan interest rate is 3.0%, your actual annual cost could be as high as 4.5% when PMI is included. For example, a $200,000 loan with a 1% PMI premium amounts to $2,000 each year. It will add about $167 to your monthly payment.
Remember, PMI protects the lender, not the borrower. PMI does not prevent a foreclosure if you don’t make the mortgage payments. For a lender to collect on PMI, it generally must foreclose on the property. The lender collects most of the foreclosed loan amount from the sale of the property. PMI will then pay the bank for the sum of the deficit up to the amount the home was originally insured for. However, as the borrower, you might gain some benefits from the right PMI.
A PMI company does not want to pay for a foreclosure. To minimize their risk, some PMI companies offer a “partial claim advance” or “job loss protection.” But only under certain circumstances. Also, you don’t get to work directly with the PMI company. Your lender must request the partial claim for you and the lender must suspend collection and foreclosure efforts while the mortgage insurer is evaluating the request. Generally, partial claim advances are only allowed if:
Some (but not all) PMI companies will help with a job loss. This will be for a limited time and granting the payments is typically based on risk to the PMI company (such as 95% of the loan still being owed). There will be severe restrictions on when job loss protection is granted. For instance, you cannot quit your job, or be fired for cause, or have a seasonal break in employment (other restrictions also apply).
Although these restrictions are very limiting, it can be a reason to shop for PMI. But shopping for PMI is not always easy or simple. For one thing, the extra benefits mentioned above could come with a higher premium rate. Also, lenders typically select the mortgage insurance for you or only work with a few PMI companies. Shopping for PMI could involve shopping for a different lender. But at the least, you should understand what you are getting with the PMI that your lender is requiring.
Even if you do have to pay for PMI to qualify for a conventional loan, these extra payments can usually be stopped once certain circumstances occur. Understanding the loan-to-value ratio (LTV) of your loan is key to removing PMI from your monthly payments. You can expect your lender to discontinue collecting for PMI once your LTV reaches 78% of the loan value of your property. This is the equity you have in the property. It does not mean you have to wait until you pay the loan down to 78% of what you borrowed. With today’s high rates of appreciation, the value of your home is increasing every month. You should expect to reach an LTV of 78% in two years of less.
However, the 78% level is the lenders threshold. The required level is 80%, which is a couple of percentage points in your favor. If your lender does not automatically stop your PMI payments, you can call or write a letter to them asking them to stop the payments as soon as your LTV hits 80%. However, your lender might require a new appraisal to verify the 80% threshold has been reached.
FHA loans have a different version called a mortgage insurance premium (MIP). You will want to know the specifics if this is the route you are going but it generally costs 0.45% to 1.05% of the loan amount and often remains for the life of the loan. Paying MIP for the entire length of the loan can be a reason to consider a conventional loan rather than an FHA loan. FHA mortgage insurance can't be canceled unless you make a down payment of at least 10%. If your down payment is 10% or more, the MIP can be cancelled after 11 years. Another way of getting out of the MIP is to refinance into a non-FHA loan once your LTV is below 80%.
What else do you think buyers need to know about mortgage insurance? Please share your insights by leaving a comment.
Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].
