Private Mortgage Insurance (PMI)
December 1, 2022
What is PMI?
Private mortgage insurance (PMI) is often required if you purchase a home using a conventional loan and have a down payment of less than 20 percent. It does not protect the homeowner from foreclosure, but it does give prospective homebuyers the opportunity to purchase a home – even when they cannot afford a 20 percent down payment.
For example, suppose you put 10 percent down on a $300,000 mortgage and borrow the remaining 90 percent. Without PMI, the lender would be responsible for the remaining balance of the mortgage. If the mortgage would go into foreclosure with an outstanding balance of $240,000 and the PMI was for 25 percent of the loan, then the lender would be covered for $60,000 of the remaining balance.
Who does PMI protect?
PMI is designed to protect lenders in cases of mortgage default. It is arranged by the lender and provided by private insurance companies. Although PMI is obtained by the lender, it is usually the borrower’s responsibility to pay for it. The homebuyer takes on this cost because mortgages involving a down payment lower than 20 percent are viewed as riskier than those with down payments 20 percent or greater.
Different types of PMI
The most common type of PMI is borrower-paid mortgage insurance (BPMI). Less common options include single-premium mortgage insurance, lender-paid mortgage insurance, and split-premium mortgage insurance. The amount you pay for PMI depends on your credit score, the size of your down payment, and the type of loan you receive. Other factors include your debt-to-income ratio, the type of property you are purchasing, and the value of the home.
- Borrower-Paid Mortgage Insurance (BPMI) – additional monthly fee included with mortgage payment. This must be paid every month until you reach 22 percent equity in the home, based on the original purchase price. Once this is fulfilled, the lender must automatically cancel BPMI if you are current on your payments. You may be able to cancel PMI early if you provide your lender with a current appraisal that shows you have accumulated 20 percent equity, the home does not have additional liens, and you have a satisfactory payment history
- Single-Premium Mortgage Insurance (SPMI) – pay mortgage insurance upfront as a lump sum at closing or include it in the mortgage. The benefit is that you may be able to obtain a lower monthly payment compared to BPMI, but the downside is that, when paid as a lump sum, none of it is refundable if you refinance or sell within a few years. Additionally, if you finance it, you will have to pay interest on it for the duration of the mortgage
- Lender-Paid Mortgage Insurance (LPMI) – the lender technically pays for the mortgage insurance with this option, but it is usually in exchange for a higher interest rate. Further, because it is built into the loan, it cannot be canceled after accumulating a certain amount of equity in the home like other mortgage insurance options
- Split-Premium Mortgage Insurance – a hybrid of BPMI and SPMI that allows the borrower to pay part of the mortgage insurance as a lump sum at closing and part monthly. This is the least common type of mortgage insurance, but it can be an appealing option for borrowers with a high debt-to-income ratio
FHA Loans
There is a fifth type of private mortgage insurance called Federal Home Loan Mortgage Protection (MIP), also known as mortgage insurance premium, which is only used with loans underwritten by the Federal Housing Administration (FHA). It is a requirement for all FHA loans with down payments of 10 percent or less. Borrowers must make a payment upfront and pay monthly premiums. If your down payment is less than 10 percent, you must pay MIP for the entirety of your loan. However, if you pay 10 percent or more, you only have to pay MIP for 11 years.
How to Remove PMI
Depending on the type you select, there are a few ways to stop paying mortgage insurance.
- Build equity in your home. Your mortgage servicer is required to stop charging PMI once your balance is 78 percent of the original loan. However, this does not apply to FHA loans, as MIP can only be canceled if you put at least 10 percent down and pay for 11 years
- Notify your servicer when you reach 20 percent equity. Although it automatically cancels at 22 percent, you can expedite the process by notifying your servicer when it reaches 20 percent
- Get a home appraisal. If your home appreciates in value, a home appraisal can confirm whether you have reached 20 percent in equity
- Refinance. This option might make sense if you are able to significantly lower your interest rate
It is important to follow the requirements of your lender and the type of loan you have for proper PMI removal. You will want to continually stay on top of how much you owe on your home compared to its value.