What is PMI insurance?
Not to be confused with homeowners insurance, PMI is mortgage insurance required on most loans when buyers don't pay at least 20 percent of the home's purchase price as a down payment. Policies cover a percentage of the loan in the event that the borrower defaults, but they do not stop the foreclosure. They pay when the home doesn’t have enough value to be sold for the loan amount in a foreclosure sale.
Most conventional mortgage lenders use the 20 percent threshold because they believe it’s enough of a cushion to regain the loan value in the event of a foreclosure. But that's not a hard-and-fast rule.
More importantly, you can sometimes have your PMI insurance cancelled once you reach 20 percent equity in your home. Keep in mind that housing markets can cause this number to vary widely even during the early years of the loan.
Types of private mortgage insurance
The five types of PMI insurance are:
- Borrower-paid mortgage insurance (BPMI). This is a monthly premium payment added to your mortgage payment and is the most common type of PMI insurance seen among borrowers. Lenders must cancel the payment once you have 22 percent equity as long as you are current on your mortgage payments, but you can usually ask your lender to cancel it when you have 20 percent equity.
- Single-premium mortgage insurance (SPMI). This is a lump sum premium payment paid at closing or rolled into the entire loan value. You may have a lower monthly bill if you pick this option, but you should note that the upfront premium isn’t refundable. If you move or refinance, you could be out of the money you spent.
- Lender-paid mortgage insurance (LPMI). In this type of PMI insurance, the lender pays the premium. However, the lender usually charges higher interest rates to cover the costs of the mortgage insurance. Moreover, you can’t cancel this type of PMI until you reach 78 percent equity in your home.
- Split-premium mortgage insurance. This is a combination of the borrower-paid and single-premium mortgage insurance policies where the borrower pays a large sum up front (or has it rolled into the loan) plus a monthly payment. People may opt for this mortgage insurance when they have a high debt-to-income ratio that would make their monthly payments too expensive with a BPMI policy.
- Mortgage Insurance Premium (MIP). The term for PMI insurance on loans from the Federal Housing Administration (FHA). MIP required for the life of an FHA loan where the borrower made a down payment of 10 percent or less.
When does PMI insurance apply to homeowners?
Lenders impose PMI insurance when the loan-to-value (LTV) ratio is more than 80 percent. The LTV compares the amount of your loan to the value of the home, so mortgage lenders use it to determine how much risk they’re taking on with a loan. The higher this ratio is (i.e., the more you have to borrow), the more risk for the lender. If you aren’t putting at least 20 percent down on the house, your lender will most likely require PMI insurance on your loan.
Every FHA loan requires mortgage insurance no matter how much your down payment is, and your payment will be slightly higher than most if you put less than five percent down. With an FHA loan, the PMI includes both an upfront payment (that can be rolled into the loan) and a monthly charge.
How much does PMI insurance cost?
PMI insurance is not cheap. Payments are anywhere from 0.25 percent to 2 percent of the loan balance per year. This means for every $100,000 you borrow, you can expect to pay between $250 to $2,000 annually for mortgage insurance. That can tack on an extra $166 per month to your monthly mortgage payment.
How much your PMI insurance costs will depend on:
- How much your down payment is.
- How much you borrow.
- The terms of your loan term.
- Your credit score.
PMI insurance can also affect your debt-to-income ratio, making it harder to qualify for your loan if the margins were narrow.
How to get private mortgage insurance removed
Sometimes your lender automatically removes the PMI insurance on your mortgage. This usually happens in one of two situations:
- You reach the midway point of your mortgage, say 15 years in on a 30-year mortgage.
- Your mortgage balance reaches 78 percent of your home’s original loan value.
In the case of the 78 percent loan balance, you don’t have to wait for that extra bit of equity. While 78 percent is the threshold for automatically dropping PMI, you can request this from the lender as soon as you have the required 20 percent equity or an 80 percent LTV.
But what happens if the house appreciates quickly and you get more than 20 percent of equity in it in just a few short years? This isn’t unheard of considering the way the housing market has been recently, but it doesn’t trigger the removal of the PMI.
If your home appreciates quickly, get an appraisal for the new home value. A professional appraisal might cost you a few hundred dollars, but it may save you thousands per year. With the new appraisal, you can request that the lender remove the PMI based on the new value. If your lender has a clause in the loan contract that won’t allow you to merely remove the PMI, common in FHA loans, you may need to refinance the house based on the new LTV.
The private mortgage insurance cancellation act
The PMI Cancellation Act, officially known as the Homeowners Protection Act, gives homeowners the right to remove and cancel PMI insurance as soon as they have built up enough equity in the property. While lender rules may vary on how you can cancel PMI, they have to give you an opportunity to do so.
Savvy homebuyers ask about the PMI schedule when signing loan documents. They want to know when the soonest they can drop PMI is based on regular payments. Accelerating payments by paying down principal may allow you to drop PMI sooner than later.
