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What is Private Mortgage Insurance?

Thursday, October 19, 2023

If you are considering buying a home and are having to be strategic with your budget, chances are you’ve heard mention of Private Mortgage Insurance (PMI). PMI can be a bit of a confusing topic, but it doesn’t have to be! By the end of this article, you’ll be able to confidently answer the question, “Do I need mortgage insurance?” We’ll demystify PMI and provide you with all the information you need to make informed decisions about your mortgage. 

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What is Private Mortgage Insurance?

Private Mortgage Insurance, or PMI, is a type of insurance that safeguards the lender in case the borrower defaults on the mortgage payments. It acts as a safety net for the lender when you don’t have the recommended down payment amount. 

The advantage of obtaining PMI is that you can still qualify for a mortgage with a down payment of less than 20%. You are able to access the market while building equity rather than having to wait until you have substantial savings. 

That said, it’s important to consider your long-term financial goals when buying a home. It’s crucial to weigh the cost of PMI against the benefits of homeownership. Does paying for PMI align with your financial goals? Will you be able to comfortably afford your mortgage plus PMI? 

When is Private Mortgage Insurance Required?

Private Mortgage Insurance is typically required in two situations:

  • Less than 20% down.

    As noted, PMI is required when you have less than 20% of the purchase price of your desired home to use as a down payment. If you have less than $100,000 to put down on a home that costs $500,000, for example, you would be required to have PMI.  
  • LTV exceeds 80%.

    The loan-to-value ratio (LTV) compares the amount of your mortgage against the appraised value of your home. The more you put down, the lower your LTV ratio. Some mortgage lenders consider the LTV when considering your loan application and if they will require PMI.

When is Private Mortgage Insurance Not Required?

There are a couple of scenarios where PMI may not be required regardless of the percentage you’re able to put down and your LTV, such as:

  • Government-backed loans.

    Loans issued by the Federal Housing Administration (FHA), the US Department of Agriculture (USDA), or the Department of Veterans Affairs (VA) have their own requirements.
  • Lender-paid mortgage insurance (LPMI).

    With LPMI, the lender pays for the Private Mortgage Insurance on behalf of the borrower in exchange for a slightly higher interest rate. 

What Does Private Mortgage Insurance Cover?

Remember, PMI is designed to protect the lender, not the borrower. PMI covers repayment to the lender if you default on your mortgage. It does not cover the equity you have in your home, your personal possessions, or your liability as a homeowner. 

How Much Is Private Mortgage Insurance?

Private Mortgage Insurance cost varies based on several factors, including your:

  • Loan-to-value ratio 
  • Credit score
  • Mortgage type and loan program

PMI is an added monthly expense that is rolled into your mortgage payment. Typically, PMI ranges from 0.2% to 2% of the loan amount per year. So, going back to our example of a house priced at $500,000, your PMI rate would be between $1,000 and $10,000 annually.

The good news is that PMI doesn’t last the life of your mortgage. There are two ways to complete your PMI obligation. Once you have built 20% equity in your home or, more simply said, your principal balance reaches 80% of the home’s original value, you are no longer required to pay PMI. 

The second way is a bit more nuanced. A provision in the Homeowners Protection Act (HPA) states that PMI must be automatically terminated when the principal balance of the mortgage reaches 78% of the original value of the property. Once the loan balance reaches 78% of the home’s original value, you’re no longer required to pay for PMI. As stated above, you can cancel it once you have 20% equity in the home; you don’t have to wait for automatic termination. 

In some cases, you may need to meet additional requirements before you can put PMI behind you, such as having a good payment history and being current on your loan payments.

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Mortgage Protection Insurance

It’s worth noting that Private Mortgage Insurance is different from Mortgage Protection Insurance (MPI). While PMI protects the lender, MPI is designed to provide financial security for the borrower and their family in case of unexpected events like death, disability, or unemployment. If you’re concerned about protecting yourself and your loved ones, MPI is an option worth exploring.

Have other questions pertaining to buying a home? Check out our 5 Tips For First-Time Homebuyers article. If you have any questions about auto, homeowners, commercial, or life insurance, connect with our team! We are always happy to provide advice and assistance tailored to your unique situation.