Private Mortgage Insurance (PMI) is a type of insurance that borrowers might be required to purchase as a condition of a conventional mortgage loan, specifically when their down payment is less than 20% of the home’s purchase price or appraised value. Unlike FHA’s Mortgage Insurance Premium (MIP), which is generally required for government-backed loans, PMI is applicable to conventional loans.
Purpose of PMI
PMI protects the lender in the event that the borrower defaults on the loan. Despite its cost to the borrower, PMI can help individuals qualify for a loan they might not otherwise be able to secure.
How PMI Works
- Monthly Premiums: PMI is often paid as a part of the monthly mortgage payment.
- Upfront Premium: Some lenders offer an option to pay PMI upfront in a single lump sum.
- Split Premium: Others may offer a combination of upfront payment and monthly premiums.
Types of PMI
- Borrower-Paid Mortgage Insurance (BPMI): The most common type, BPMI is a monthly fee included in the borrower’s mortgage payment.
- Lender-Paid Mortgage Insurance (LPMI): The lender pays the insurance premium upfront and incorporates the cost into the mortgage interest rate.
- Single-Premium Mortgage Insurance (SPMI): A one-time upfront premium paid at closing.
- Split-Premium Mortgage Insurance: A combination of an upfront payment and monthly payments.
Practical Considerations
How to Cancel PMI
PMI can generally be canceled once the borrower’s equity reaches 20% of the home’s purchase price or appraised value, under certain conditions:
- LTV Ratio: Lenders are required by the Homeowners Protection Act to cancel PMI once the homeowner’s loan-to-value ratio (LTV) reaches 78% of the original value, provided the mortgage is current.
- Request: Borrowers may request PMI cancellation once they believe the LTV ratio has reached below 80%. This request typically also requires a good payment history.
PMI vs. MIP
- PMI: For conventional loans with less than 20% down payment.
- MIP: Mandatory for FHA loans, regardless of down payment size.
| Feature | PMI | MIP |
|---|---|---|
| Applicable Loans | Conventional | FHA |
| Down Payment | < 20% | Any (with less flexibility) |
| Cancellation | Possible when reaching 20% equity | Typically not cancelable, depending on the loan term and down payment |
Cost of PMI
The cost of PMI varies based on several factors:
- Loan Amount: Higher loan amounts lead to higher PMI costs.
- Down Payment: Smaller down payments result in higher PMI premiums.
- Credit Score: Borrowers with lower credit scores may face higher PMI rates.
Examples
Imagine purchasing a home for $300,000 with a 10% down payment ($30,000). With a $270,000 loan amount:
- Monthly PMI: For BPMI, the borrower might pay between $67.50 (0.25%) to $202.50 (0.75%) per month.
- Upfront PMI: For SPMI, the cost might be 0.5% to 1.5% of the loan amount ($1,350 to $4,050) upfront.
FAQs About PMI
Q: Is PMI tax-deductible? A: PMI may be tax-deductible, subject to income limits and other conditions.
Q: Can PMI be avoided without a 20% down payment? A: Yes. Methods like “piggyback loans” (80-10-10 loans) allow borrowers to avoid PMI by taking out a second loan.
Q: Does PMI offer any benefits to borrowers? A: While PMI primarily benefits lenders, it enables borrowers to purchase homes without a 20% down payment.
Conclusion
PMI is an insurance product that serves to protect lenders from the risk of borrower default, but it also helps more borrowers qualify for home loans, enabling the purchase of homes with smaller down payments. While it adds to the cost of the mortgage, understanding the workings of PMI can help borrowers make informed financial decisions and potentially eliminate it sooner.
References:
- “The Homeowner’s Protection Act,” Consumer Financial Protection Bureau
- “Understanding Mortgage Insurance,” Mortgage Bankers Association
- “PMI: What Private Mortgage Insurance Is And How To Avoid It,” Forbes Contributor Network
