Private Mortgage Insurance: How It Influences Your Home Loan Process

What Is Private Mortgage Insurance (PMI)? 

Private Mortgage Insurance (PMI) is a type of insurance policy that protects the lender in case the borrower defaults on their mortgage payments. It is usually required when a borrower puts down less than 20% of the home’s purchase price as a down payment. The cost of PMI varies depending on the size of the down payment, the loan amount, and the borrower’s credit score. PMI is typically added to the borrower’s monthly mortgage payment until the equity in the home reaches 20%.

Most lenders will ask homebuyers with limited spending power to purchase supplemental private mortgage insurance. While general homeowners insurance protects the homeowner from covered perils like fires and storms, private mortgage insurance solely protects the mortgage lender if the borrower defaults or forecloses on their home. Since these lenders must stake more money on high-balance mortgages, they take on more risk, thus requiring PMI.  

Do You Need Private Mortgage Insurance? 

With housing costs steadily rising, many aspiring homeowners with less than robust financial indicators have encountered difficulty securing affordable loans. By paying for extra coverage that guarantees their lender’s protection, borrowers can put as little as 3% down on their mortgage when closing on a home.

However, PMI is not necessary for all buyers. An individual with better financial indicators or enough liquid assets to put down a 20% down payment off the bat will not be required to purchase this coverage.

How Private Mortgage Insurance Works 

New homeowners with less than 20% initial equity must purchase private mortgage insurance as protection for their mortgage lenders, not themselves. This monthly insurance premium guarantees some level of coverage for their lender should they default on their home loan.  

While PMI clears up some immediate obstacles to buying a home, these additional premiums notably increase monthly mortgage payments. Homeowners can only request PMI removal once they have reduced their home’s loan-to-value (LTV) ratio to 80%.

Types of Private Mortgage Insurance

Luckily, if you must resort to PMI to qualify for a mortgage, you can choose to pay it off a few separate ways. Explore the following options and select the type of plan that works best for you:

• Single premium PMI: You pay the mortgage payment upfront as one lump sum, presented either when you close on your home or financed into your mortgage.
• Monthly PMI: Your PMI premium gets broken up and added to your mortgage as monthly payments, indicated separately on your bill.
• Split premium PMI: You pay a larger sum upfront to eat up some of your overall PMI premium, reducing the cost of your monthly payments. 
• Borrower-paid PMI: Borrower-paid PMI requires payment of an additional monthly premium with your homeowners insurance. 
• Lender-paid PMI: While lenders technically offer to pay for this type of PMI, they charge a higher mortgage rate for the service. Borrowers then pay higher interest through the total loan length or until they refinance their mortgage.

How PMI Works With FHA Loans

Federal Housing Administration loans require as little as 3.5% of the property’s purchase price as a down payment, appealing to young, first-time buyers with limited funds and credit history. Even individuals who have filed for bankruptcy or experienced other drawbacks hindering them from traditional loans may still qualify for an FHA mortgage, given they meet standard eligibility requirements.  

Similarly to split premium PMI, FHA loans ask for a larger payment upfront, followed by a series of monthly mortgage insurance premiums (MIPs) over the life of the loan that ultimately increase the final cost of your mortgage. Unlike standard PMI, federal regulations do not allow you to cancel MIP, regardless of your initial down payment or current home equity.

How PMI Works With VA and USDA Loans 

Department of Veteran’s Affairs (VA) loans and U.S. Department of Agriculture (USDA) mortgages do not require private mortgage insurance. VA loans ask for a one-time funding fee that borrowers can pay upfront at closing or have built into their loan. These fees vary depending on your home equity and initial down payment and do not apply to disabled veterans or the surviving spouses of service members lost in action.  

USDA loans ask for upfront and annual “guarantee” fees until you pay off your house, sell it, or refinance your mortgage. Fees or no fees, USDA and VA loans tend to cost less than conventional mortgages requiring PMI and impose much lower credit standards, making them an ideal alternative for qualified applicants.

How Much Does Private Mortgage Insurance Cost? 

Eligible borrowers typically pay $30 to $70 monthly in PMI premiums for every $100,000 of their original loan. Though PMI rates depend on multiple factors specific to your personal life, down payment, and home equity, average costs typically fall around 0.58% to 1.86% of your original loan. 

Your Credit Score, History, and Debt-to-Income Ratio 

Your credit score, history, and debt-to-income ratio demonstrate your reliability to potential lenders. A score of 760 or higher, a history of timely payments, and a DTI of less than 45% should solidify your trustworthiness in the eyes of most lenders and evoke lower PMI premiums. If your credit score dips under 700, you have a checkered credit history, or you hold substantial existing debt, you may prove better off looking into an FHA loan. 

Your Home’s Details

Single-family homes often elicit the lowest PMI premiums, whereas multifamily residences, condos, townhomes, and manufactured homes usually cost more. Lenders see the latter dwellings as riskier loan bets due to HOA coverage restrictions and the liabilities presented by so many neighboring units and people.

Most lenders also see second homes, investment properties, and vacation homes as high risk, calculating that struggling borrowers are more likely to skip these mortgage payments to focus on paying off their primary residence loans. Therefore, PMI for secondary homes costs more.

Loan-to-value (LTV) ratio 

Your home’s loan-to-value ratio refers to the amount of your home’s value you intend to or have already borrowed, directly determining your home equity. The higher your home equity at closing, the lower you’ll have to pay in private mortgage insurance. Once your equity meets or exceeds 20% (or, in other words, your LTV falls below 80%), you will not need to continue paying for PMI.

Down Payment Amount 

Your down payment directly impacts your LTV and ultimately decides your PMI premium. For example, a down payment of 5% leaves you with an LTV of 95%, representing the financial risk your lender has taken on. Smaller down payments equal higher risk, thus leading to higher PMI premiums.

Your Loan Details 

Lenders consider adjustable-rate mortgages (loans that go up and down with the marketplace) as higher risk and charge higher PMI premiums. Alternatively, they assume borrowers will have an easier time paying fixed-rate mortgages because they can consistently expect how much money to set aside for each monthly payment.

Lenders also charge lower PMI premiums for loans with terms under 20 years, as they’d hypothetically have to shoulder the risk of the loan for a shorter duration.

How to Keep Your PMI Costs Down 

You can keep your PMI costs down by pooling all your available funds toward your down payment. Otherwise, try shopping for lenders offering lower rates or researching ones who allow greater leniency for borrowers with poor credit histories. Stick to a fixed-rate mortgage, and if you can afford the initial payment, opt for a single premium or split premium PMI.

Advantages and Drawbacks of Paying For PMI 

While private mortgage insurance allows lower-income and higher-risk buyers to own a home, it presents its own problems. Before moving forward, consider all the advantages and drawbacks of paying for PMI.

Advantages of PMI 

Some of the key advantages of private mortgage insurance include the following:

• It can help you qualify for a home loan: By paying extra to protect their lenders, PMI can help higher-risk and lower-income borrowers qualify for loans typically unattainable to them.
• It lowers your down payment requirement: Standard loans require borrowers to put up at least 20% of their home’s total value at closing. With PMI, borrowers with limited resources can make down payments as low as 3% of their home’s purchasing cost.
• It does not affect your mortgage’s interest rate: If you opt for borrower-paid mortgage insurance, your PMI will not raise the interest on your loan. Instead, PMI payments get rolled into your monthly bill as separate charges. On the contrary, however, lender-paid PMI would markedly increase your interest.

Drawbacks of PMI 

Though the perks of PMI may sound appealing, make sure to consider all the following drawbacks:

• It adds to your monthly mortgage costs: While PMI helps you afford a home with minimal upfront costs, you still pay for it on the back end through your mortgage premiums.
• It protects your lender, not you: Even though you personally pay for PMI, it only covers your lender if you default or foreclose on your mortgage. Coverage does not extend to the borrower.
• It can be difficult to cancel or remove: Upon reaching 20% equity, you’ll still have to jump through some hoops to cancel your PMI. Lenders might even ask you to pay for an official appraisal or refinance your mortgage to remove coverage.

Avoid Private Mortgage Insurance Altogether With Alternative Options 

Though PMI offers many benefits, the long-term commitment to additional debt may deter some people. Luckily, there exist alternatives to PMI for some eligible homebuyers, including:

• Piggyback Mortgage: This entails taking out two mortgages in unison. After making a small down payment out-of-pocket, you use a conventional mortgage to pay off the majority of your loan balance and a smaller home equity loan to bring your down payment up to 20% of your home’s value. Though you must account for two mortgage payments concurrently, you avoid paying PMI premiums.
• FHA Loan: FHA loans still require monthly mortgage insurance premiums (MIPs) but tend to cost less than PMI. FHA loans allow some buyers to purchase a home for as low as 3.5% down without factoring in their credit history.
• VA Loans: Military veterans or their widowed spouses may qualify for loans backed by the Department of Veterans Affairs that exempt them from down payments and PMI.

Canceling and Removing Private Mortgage Insurance 

In light of previous difficulties encountered by many homeowners attempting to cancel their PMI, the Homeowners Protection Act of 1998 laid down official provisions for termination. Prior to this act, borrowers held limited recourse when lenders denied PMI cancellation requests. You can now request to remove PMI from your mortgage once one of the following has occurred:

• You reach 20% equity by paying your principal balance down to 80% of your original loan. 
• Your property significantly appreciates in value through strategic home improvements or fluctuating market conditions.

According to the Homeowners Protection Act, lenders can no longer impose life-of-loan coverage on borrower-paid PMI, risking litigation if they attempt otherwise.

Ways to Cancel Your PMI 

You can officially cancel your PMI in one of three ways:

• Ask your lender to cancel your PMI
• Wait for automatic termination of your PMI
• Wait for final termination of your PMI

Each method of cancelation carries some nuance, as detailed below.

Ask your lender to cancel your PMI 

You have the right to request PMI cancellation on the official date that the principal balance of your mortgage is scheduled to fall to 80% of your home’s original value. You could request earlier cancellation if you made substantial contributions to pay down your home’s initial value ahead of schedule.

To officially request termination, borrowers must abide by these guidelines:

• Submit a request in writing.
• Stay ahead of payments up to the date in question.
• Certify they have no junior liens, such as second mortgages, on their home.
• Provide evidence that their home has retained its value, often through official appraisal.

Wait for automatic termination of your PMI 

Your servicer must automatically cancel your PMI once your principal balance reaches 78% of your home’s original value, even if you don’t officially request termination. For this to go through, you must remain up-to-date on all payments leading up to automatic cancellation. If not, your PMI will remain active until you catch up on the charges.

Wait for final termination of your PMI 

Lenders must conclusively end PMI after a loan reaches the midpoint of its amortization schedule. So for a 30-year mortgage, final termination would occur 15 years into the loan, even for buyers who have not reduced their balance to 78% of their home’s original value.

Final termination typically only applies to mortgages that started with interest-only periods or principal forbearance. Borrowers must have remained up-to-date on their payments for final termination of their PMI to take effect.

What This Means For You 

If you have limited resources, private mortgage insurance could help you qualify for an otherwise unattainable home loan. However, PMI can present its own difficulties and cost you a lot in extra premium payments through the years.  

Explore your options before committing to a mortgage requiring PMI. Depending on your situation, you might reduce the overall cost of your PMI or even qualify for alternative loans that help you avoid PMI entirely. Compare at least three mortgage options before settling on a loan that best fits your situation.