Private Mortgage Insurance (PMI) is a topic that often comes up when discussing home loans, particularly for those unable to make a substantial down payment. Understanding what PMI is, why lenders require it, how to avoid it, and the steps to have it removed can save homeowners a significant amount of money. Here’s an in-depth look at PMI insurance and its implications for homebuyers.
What is PMI?
Private Mortgage Insurance (PMI) is a type of insurance that lenders require when a borrower is unable to make a down payment of at least 20% of the home’s purchase price. The primary purpose of PMI is to protect the lender in case the borrower defaults on the loan. While PMI protects the lender, the cost of this insurance is typically borne by the borrower.
When and Why Do Lenders Require PMI?
Lenders require PMI on conventional loans when the down payment is less than 20% because such loans are considered higher risk. Here’s why lenders enforce this requirement:
- Risk Mitigation: Borrowers who make smaller down payments have less equity in their homes and are viewed as more likely to default on their loans. PMI reduces the lender’s risk by providing financial protection.
- Loan Security: In the event of foreclosure, PMI compensates the lender for part of the loss, ensuring they recover some of the loan amount.
How to Avoid PMI
Avoiding PMI can be beneficial for borrowers as it eliminates an extra monthly cost. Here are a few strategies to avoid PMI:
- Make a Larger Down Payment: The most straightforward way to avoid PMI is to make a down payment of at least 20% of the home’s purchase price.
- Piggyback Loans: Sometimes called an 80-10-10 loan, this involves taking out a second mortgage to cover part of the down payment. For example, you might get a primary mortgage for 80% of the purchase price, a second mortgage for 10%, and then make a 10% down payment.
- Lender-Paid PMI: Some lenders offer loans with lender-paid PMI, where the cost of PMI is incorporated into a slightly higher interest rate. While this avoids monthly PMI payments, it can result in higher overall interest costs over the life of the loan.
- Shop for Special Programs: Some loan programs, such as VA loans for veterans and USDA loans for rural properties, do not require PMI regardless of the down payment amount.
Does PMI Get Added to Your Finance Payment?
Yes, PMI is typically added to your monthly mortgage payment. The cost of PMI can vary based on several factors, including the size of the down payment, the loan amount, and the borrower’s credit score. On average, PMI costs range from 0.3% to 1.5% of the original loan amount per year. This amount is usually broken down into monthly payments and included in your mortgage bill.
How to Have PMI Removed
Once you have built up enough equity in your home, you can have PMI removed. Here’s how:
- Automatic Termination: By law, your lender must automatically terminate PMI once your loan balance reaches 78% of the original property value. This means you have 22% equity in your home.
- Borrower-Initiated Cancellation: You can request PMI cancellation earlier if your loan balance reaches 80% of the original property value. To do this, you typically need to submit a written request to your lender.
- Appraisal-Based Cancellation: If you believe your home has appreciated in value, you can request PMI removal based on a new appraisal. If the appraisal shows that you have at least 20% equity, your lender may agree to remove PMI.
- Home Improvements: If you have made significant improvements to your home that have increased its value, you can also request an appraisal to potentially eliminate PMI based on the new, higher value of your home.
Steps to Remove PMI
- Check Your Loan Balance: Regularly monitor your mortgage statements to see when your loan balance reaches 80% of the original purchase price.
- Contact Your Lender: Once you believe you qualify, contact your lender to discuss PMI removal. Be prepared to provide documentation or arrange for an appraisal.
- Submit a Written Request: Write a formal request for PMI cancellation and submit it to your lender, including any required documents.
- Appraisal: If necessary, arrange for a home appraisal and submit the results to your lender.
- Follow Up: Ensure that your lender has processed your request and confirm that PMI has been removed from your mortgage payments.
Conclusion
Private Mortgage Insurance is a significant consideration for homebuyers, particularly those unable to make a large down payment. While PMI adds to your monthly mortgage payment, it can be avoided or removed with careful planning and financial management. By understanding how PMI works and taking proactive steps, you can minimize its impact on your finances and potentially save thousands of dollars over the life of your loan.
