If you’re making a down payment of less than 20% on a home, it’s important to understand what mortgage insurance is and how it works. Private mortgage insurance (PMI) isn’t just for people who can’t afford a 20% down payment. It’s also for people who don’t want to put down 20%, so they have more cash on hand for repairs, remodeling, furnishings, and emergencies.
What Is Private Mortgage Insurance – PMI?
If the concept of buying insurance on your mortgage sounds a little odd, you’re probably a newcomer to buying a property or never put down a small down payment. Most lenders require PMI when a home buyer makes a down payment of less than 20% of the home’s purchase price – or, in mortgage-speak, the mortgage’s loan-to-value (LTV) ratio is in excess of 80% (the higher the LTV ratio, the higher the risk profile of the mortgage). And unlike most types of insurance, the policy protects the lender’s investment in the home, not yours. On the other hand, PMI makes it possible for people to become homeowners sooner.
PMI allows borrowers to obtain financing if they can only afford (or prefer) to put down just 5% to 19.99% of the residence’s cost, but it comes with additional monthly costs. Borrowers pay their PMI until they have accumulated enough equity in the home that the lender no longer considers them high-risk.
PMI costs can range from 0.25% to 2% (but typically run about 0.5 to 1%) of your loan balance per year, depending on the size of the down payment and mortgage, the loan term and your credit score. The greater your risk factors, the higher the rate you pay. Also, because PMI is a percentage of the loan amount, the more you borrow, the more PMI you’ll pay. There are six major PMI companies in the United States. They charge similar rates, which are adjusted annually.
It’s an added expense, but so is continuing to spend money on rent and possibly missing out on market appreciation while you wait to save up a larger down payment. There’s no guarantee you’ll come out ahead buying a home later rather than sooner just to avoid it, so the value of paying PMI is worth considering. The value of paying Federal Housing Administration mortgage insurance – what you may need if you get an FHA loan – is another story. We’ll explain that later.
Some Key Takeaways:
- You will need private mortgage insurance (PMI) if you’re purchasing a home with a down payment of less than 20% of the home’s cost.
- Be aware that PMI is intended to protect the lender, not the borrower, against potential losses.
- There are four main types of mortgage insurance you can purchase: Borrower-Paid Mortgage Insurance, Single-Premium Mortgage Insurance,
- Lender-Paid Mortgage Insurance, and Split-Premium Mortgage Insurance.
- If you obtain a Federal Housing Authority loan for your home purchase, there is an additional type of insurance you will need.
- Mortgage Insurance Coverage
First, you should understand how PMI works. For example, suppose you put down 10% and get a loan for the remaining 90% of the property’s value – $20,000 down and a $180,000 loan. With mortgage insurance, if the lender has to foreclose on your mortgage because you lose your job and can’t pay for several months, the lender’s losses will be limited.
The mortgage insurance company covers a certain percentage of the lender’s loss. For our example, let’s say that percentage is 25%. So if you still owed 85% ($170,000) of your home’s $200,000 purchase price at the time you were foreclosed on, instead of losing the full $170,000, the lender would only lose 75% of $170,000, or $127,500 on the home’s principal. PMI would cover the other 25%, or $42,500. It would also cover 25% of the delinquent interest you had racked up and 25% of the lender’s foreclosure costs.
If PMI protects the lender, why do you, the borrower, have to pay for it? You’re compensating the lender for taking on the higher risk of lending to you versus lending to someone with a larger down payment, someone who has more to lose if his or her home gets foreclosed on.
How Long Do You Carry PMI?
Borrowers can request that monthly mortgage insurance payments be eliminated once the loan-to-value ratio drops below 80%. Once the mortgage’s LTV ratio drops to 78% – meaning your down payment, plus the loan principal you’ve paid off, equals 22% of the home’s purchase price – the lender must automatically cancel PMI as required by the federal Homeowners Protection Act, even if your home’s market value has gone down (as long as you’re current on your mortgage).
Otherwise, the length of time you have to carry PMI depends on the type of PMI you choose.
1. Borrower-Paid Mortgage Insurance
The most common type of PMI is borrower-paid mortgage insurance (BPMI). When you read about PMI and the type isn’t specified, this is usually the kind that’s being discussed.
BPMI comes in the form of an additional monthly fee that you pay with your mortgage payment. After your loan closes, you pay BPMI every month until you have 22% equity in your home based on the original purchase price. At that point, the lender must automatically cancel BPMI, as long as you’re current on your mortgage payments. Accumulating enough home equity through regular monthly mortgage payments to get BPMI canceled generally takes about 11 years.
You can also be proactive and ask the lender to cancel BPMI when you have 20% equity in your home. Your mortgage payments must be current, you must have a satisfactory payment history, there must not be any additional liens on your property and, in some cases, you may need a current appraisal to substantiate your home’s value and prove that it hasn’t declined below the value when you purchased it.
Some loan servicers will allow (but are not required to allow) borrowers to cancel PMI sooner based on home value appreciation. If the borrower accumulates 25% equity due to appreciation in years two through five, or 20% equity after year five, the investor who purchased the loan (most mortgages are sold to investors) may allow PMI cancelation after the home’s increased value is proved with an appraisal, a broker’s price opinion (BPO) or an automated valuation model (AVM, which takes into account the value of recently sold similar properties).
You also may be able to get rid of PMI early by refinancing, though you’ll have to weigh the cost of refinancing against the costs of continuing to pay mortgage insurance premiums. You may also be able to ditch it early by prepaying your mortgage principal so that you have at least 20% equity.
You need to decide if you’re willing to pay PMI for up to 11 years in order to buy now. Look beyond the monthly payment. What will PMI cost you in the long run? What will waiting to buy potentially cost you? Yes, you miss out on accumulating home equity while you’re renting, but you also avoid all the throw-away costs of homeownership, such as homeowner’s insurance, property taxes, maintenance, and repairs. And the 2017 Tax Cuts and Jobs Act, which doubled the standard deduction, makes the mortgage-interest tax deduction no longer as valuable as it was before.
The remaining three types of PMI aren’t nearly as common. You might still want to know how they work, though, in case one of them sounds more appealing or your lender presents you with more than one mortgage insurance option.
2. Single-Premium Mortgage Insurance
With single-premium mortgage insurance (SPMI), also called single-payment mortgage insurance, you pay mortgage insurance up front in a lump sum, either in full at closing or financed into the mortgage (in the latter case, it may be called single-financed mortgage insurance).
The benefit of SPMI is that your monthly payment will be lower compared to BPMI. This can help you qualify to borrow more to buy your home. Another benefit is that you don’t have to worry about refinancing to get out of PMI – or watching your loan-to-value ratio to see when you can get your PMI canceled.
The risk is that if you refinance or sell within a few years, no portion of the single premium is refundable. Further, if you finance the single premium, you’ll pay interest on it for as long as you carry the mortgage. Also, if you don’t have enough money for a 20% down payment, you may not have the cash to pay a single premium up front. However, the seller or, in the case of a new home, the builder can pay the borrower’s single-premium mortgage insurance. You can always try negotiating that as part of your purchase offer.
If you plan to stay in the home for three or more years, single-premium mortgage insurance may save you money. Ask your loan officer to see if this is indeed the case. And be aware that not all lenders offer single-premium mortgage insurance.
3. Lender-Paid Mortgage Insurance
With lender-paid mortgage insurance (LPMI), your lender will technically pay the mortgage insurance premium. In fact, you will actually pay for it over the life of the loan in the form of a slightly higher interest rate. Unlike BPMI, you can’t cancel LPMI when your equity reaches 78% because it’s built into the loan. Refinancing will be the only way to lower your monthly payment. Your interest rate will not decrease once you have 20% or 22% equity. Lender-paid PMI is not refundable.
The benefit of lender-paid PMI, despite the higher interest rate, is that your monthly payment could still be lower compared with making monthly PMI payments, and you could qualify to borrow more.
4. Split-Premium Mortgage Insurance
Split-premium mortgage insurance is the least common type. It’s a hybrid of the first two types we discussed: BPMI and SPMI.
Here’s how it works: You pay part of the mortgage insurance as a lump sum at closing and part monthly. You don’t have to come up with as much extra cash up front as you would with SPMI, nor do you increase your monthly payment by as much as you would with BPMI. One reason to choose split-premium mortgage insurance is if you have a high debt-to-income ratio. When that’s the case, increasing your monthly payment too much with BPMI would mean not qualifying to borrow enough to purchase the home you want.
The upfront premium might range from 0.50% to 1.25% of the loan amount. The monthly premium will be based on the net loan-to-value ratio before any financed premium is factored in.
As with SPMI, you can ask the builder or seller – or even the lender – to pay the initial premium, or you can roll it into your mortgage. Split premiums may be partly refundable once mortgage insurance is canceled or terminated.
5. Federal Home Loan Mortgage Protection – MIP
There is also a fifth type of mortgage insurance used with loans underwritten by the Federal Housing Administration, better known as an FHA loan or FHA mortgage. The FHA insurance is known as MIP and is a requirement on FHA loans and with down payments of 10% or less cannot be removed without refinancing the home. MIP requires an upfront payment and monthly premiums usually added to the monthly mortgage note. The buyer must still wait 11 years before they can remove the MIP from the loan if they had a down payment of more than 10%.
Cost of PMI
Your mortgage insurance costs, or premiums, will depend on several of the following factors:
- Which premium plan you choose
- Whether your interest rate is fixed or adjustable
- Your loan term (usually 15 or 30 years)
- Your down payment or loan-to-value ratio (LTV) (a 5% down payment gives you a 95% LTV; 10% down makes your LTV 90%)
- The amount of mortgage insurance coverage required by the lender or investor (it can range from 6% to 35%)
- Whether the premium is refundable or not
- Your credit score
- Any additional risk factors, such as the loan being for a jumbo mortgage, investment property, cash-out refinance or second home
In general, the riskier you look on any factor, the higher your premiums will be. For example, the lower your credit score and the lower your down payment, the higher your premiums will be.
As of early April 2018, premiums can range from 0.17% to 2.81% or more per year. If you put down 15% on a 15-year fixed-rate mortgage and have a credit score of 760 or higher, for example, you’d pay 0.17%, because you’re a low-risk borrower. If you put down 3% on a 30-year adjustable-rate mortgage for which the introductory rate is fixed for only three years and you have a credit score of 630, your rate will be 2.81%, because you’re a high-risk borrower.
Once you know which percentage applies to your situation, multiply it by the amount you’re borrowing. Then divide that amount by 12 to see what you’ll pay each month. For example, a loan of $200,000 with an annual premium of 0.65% would cost $1,300 per year ($200,000 x .0065), or $108 per month ($1,300/12).
Many companies offer mortgage insurance. Their rates may differ slightly, and your lender, not you, will select the insurer. Nevertheless, you can get an idea of what rate you will pay by studying the mortgage insurance rate card. MGIC, Radian, Essent, National MI, United Guaranty and Genworth are some major providers of private mortgage insurance.
Mortgage insurance rate cards can be confusing at first glance. Here’s how to use them.
- Find the column that corresponds to your credit score.
- Find the row that corresponds to your LTV ratio.
- Identify the applicable coverage line. Search the web for Fannie Mae’s Mortgage Insurance Coverage Requirements to identify how much coverage is required for your loan, or ask your lender (and impress the pants off them with your knowledge of how PMI works).
- Identify the PMI rate that corresponds with the intersection of your credit score, down payment and coverage.
- If applicable, add or subtract to that rate the amount from the adjustment chart (below the main rate chart) that corresponds with your credit score. For example, if you’re doing a cash-out refinance and your credit score is 720, you might add 0.20 to your rate.
- As we showed in the previous section, multiply the total rate by the amount you’re borrowing; this is your annual mortgage insurance premium.
- Divide it by 12 to get your monthly mortgage insurance premium.
- Your rate will be the same every month, though some insurers will lower it after 10 years. However, that’s just before the point when you should be able to drop coverage anyway so any savings won’t be that significant.
FHA Mortgage Insurance
Mortgage insurance works differently with Federal Housing Administration loans. For many – if not most – borrowers it will be more expensive than PMI.
PMI doesn’t require you to pay an up-front premium unless you choose single-premium or split-premium mortgage insurance. (In the case of single-premium mortgage insurance, remember that you pay no monthly mortgage insurance premiums. In the case of split-premium mortgage insurance, you pay lower monthly mortgage insurance premiums.) However, with FHA mortgage insurance everyone must pay an up-front premium, and that payment does nothing to reduce your monthly premiums.
As of April 2018, the up-front mortgage insurance premium (UFMIP) is 1.75% of the loan amount. You can pay this amount at closing or finance it as part of your mortgage. The UFMIP will cost you $1,750 for every $100,000 you borrow. If you finance it, you’ll pay interest on it too, making it more expensive over time. The seller is permitted to pay your UFMIP as long as the seller’s total contribution toward your closing costs doesn’t exceed 6% of the purchase price.
With an FHA mortgage, you’ll also pay a monthly mortgage insurance premium (MIP) of 0.45% to 1.05% of the loan amount based on your down payment and loan term. For example, as the table below from the FHA shows, if you have a 30-year loan (mortgage term of more than 15 years) for $200,000 (base loan amount less than or equal to $625,500) and you’re paying the FHA’s minimum down payment of 3.5% (LTV greater than 95%), your MIP will be 0.85% (85 bps, or basis points) for the life of the loan (mortgage term). Not being able to cancel your MIPs can be costly.
The Bottom Line
Mortgage insurance costs borrowers money, but it enables them to become homeowners sooner by reducing the risk to financial institutions of issuing mortgages to people with small down payments. You might find it worthwhile to pay mortgage insurance premiums if you want to own a home sooner rather than later for lifestyle or affordability reasons. Adding to the reasons for doing this: Premiums can be canceled once your home equity reaches 80% if you’re paying monthly PMI or split-premium mortgage insurance.
However, you might think twice if you’re in the category of borrowers who would have to pay FHA insurance premiums for the life of the loan. While you might be able to refinance out of an FHA loan later to get rid of PMI, there’s no guarantee that your employment situation or market interest rates will make a refinance possible or profitable. (For related reading, see “How To Avoid Paying Private Mortgage Insurance—PMI”)
Before buying a home, you should ideally save enough money for a 20% down payment. If you can’t, it’s a safe bet that your lender will force you to secure private mortgage insurance (PMI) prior to signing off on the loan, if you’re taking out a conventional mortgage. The purpose of the insurance is to protect the mortgage company if you default on the note.
The FHA has a similar mortgage insurance premium requirement for those taking out FHA mortgages, with somewhat different rules. This article is about PMI, but the reasons to avoid it apply to both types of loans.
PMI sounds like a great way to buy a house without having to save as much for a down payment. Sometimes it is the only option for new homebuyers. However, there are good reasons why you should try to avoid needing PMI. Here are six, along with a possible way for those without a 20% down payment to sidestep it altogether.
Some Key Takeaways
- The purpose of PMI insurance is to protect the mortgage company if you default on the note.
- There are good reasons why you should try to avoid needing PMI.
- In some circumstances, PMI can be avoided by using a piggyback mortgage.
Six Good Reasons to Avoid Private Mortgage Insurance
- Cost – PMI typically costs between 0.5% to 1% of the entire loan amount on an annual basis. You could pay as much as $1,000 a year—or $83.33 per month—on a $100,000 loan, assuming a 1% PMI fee. However, the median listing price of U.S. homes, according to Zillow, is $279,000 (as of Feb. 28, 2019), which means families could be spending as much as $233 a month on the insurance. That’s as much as a small car payment!
2. No Longer Deductible – Up until 2017, PMI was still tax deductible, but only if a married taxpayer’s adjusted gross income was less than $110,000 per year. This meant that many dual-income families were left out in the cold. The 2017 Tax Cuts and Jobs Act ended the deduction for mortgage insurance premiums entirely, starting in 2018.
3. Your Heirs Get Nothing – Most homeowners hear the word “insurance” and assume that their spouse or kids will receive some sort of monetary compensation if they die, which is not true. The lending institution is the sole beneficiary of any such policy, and the proceeds are paid directly to the lender (not indirectly to the heirs first). If you want to protect your heirs and provide them with money for living expenses upon your death, you’ll need to obtain a separate insurance policy. Don’t be fooled into thinking PMI will help anyone but your mortgage lender.
4. Giving Money Away – Homebuyers who put down less than 20% of the sale price will have to pay PMI until the total equity of the home reaches 20%. This could take years, and it amounts to a lot of money you are literally giving away. To put the cost into better perspective, if a couple who owns a $250,000 home were to instead take the $208 per month they were spending on PMI and invest it in a mutual fund that earned an 8% annual compounded rate of return, that money would grow to $37,707 (assuming no taxes were taken out) within 10 years.
5. Hard to Cancel – As mentioned above, usually when your equity tops 20%, you no longer have to pay PMI. However, eliminating the monthly burden isn’t as easy as just not sending in the payment. Many lenders require you to draft a letter requesting that the PMI be canceled and insist upon a formal appraisal of the home prior to its cancelation. All in all, this could take several months, depending upon the lender, during which PMI still has to be paid.
6. Payment Goes On and On – One final issue that deserves mentioning is that some lenders require you to maintain a PMI contract for a designated period. So, even if you have met the 20% threshold, you may still be obligated to keep paying for the mortgage insurance. Read the fine print of your
How to Avoid Paying PMI
In some circumstances, PMI can be avoided by using a piggyback mortgage. It works like this: If you want to purchase a house for $200,000 but only have enough money saved for a 10% down payment, you can enter into what is known as an 80/10/10 agreement. You will take out one loan totaling 80% of the total value of the property, or $160,000, and then a second loan, referred to as a piggyback, for $20,000 (or 10% of the value). Finally, as part of the transaction, you put down the final 10%, or $20,000.
By splitting up the loans, you may be able to deduct the interest on both of them and avoid PMI altogether. Of course, there is a catch. Very often the terms of a piggyback loan are risky. Many are adjustable-rate loans, contain balloon provisions, or are due in 15 or 20 years (as opposed to the more standard 30-year mortgage). (For related reading, see “How To Avoid Paying Private Mortgage Insurance—PMI”)
The Bottom Line
PMI is expensive. Unless you think you’ll be able to attain 20% equity in the home within a couple of years, it probably makes sense to wait until you can make a larger down payment or consider a less expensive home, which will make a 20% down payment more affordable.
Now we’ll talk just a little bit about T&I and P&I
You make a lump-sum payment to cover a combination of principal, interest, taxes, and insurance (PITI) when your mortgage payment includes an escrow account. The balances owed for taxes and homeowners insurance may be referred to as “T&I” on your mortgage statement. To ensure that these costs are paid on time, your lender collects taxes and insurance payments in addition to your principal and interest. Until you have enough equity in your house, you may have to pay these charges with your mortgage.
T&I includes the amount of property taxes you will owing to your city or town. The annual cost of your taxes was projected in your loan documents at closing, and the mortgage company divided that cost by 12 so you could put a portion into your escrow account with each monthly mortgage payment. When your property taxes are due, your lender will pay them from the escrow account on your behalf.
Maintaining adequate homeowners insurance on your property is critical; else, your lender will purchase a costly force-placed policy on your behalf. You will deposit a monthly sum into your escrow account to cover homeowners insurance so that your lender can pay your insurance bill when it is due. After an escrow examination, the lender will make the required adjustments to the T&I balance on your account if your homeowners insurance premium increases or reduces.
Private Mortgage Insurance
Private mortgage insurance, sometimes known as PMI, is a component of the T&I balance on your mortgage statement. If your down payment is less than 20% of the home’s purchase price, your lender will almost certainly require this insurance. It safeguards the lender against the possibility that you will default on your mortgage. The cost of PMI is determined by the conditions of your loan, and while you can pay it ahead, most borrowers include it in their escrow payments.
Eliminating T&I Escrow
With some loans and under certain situations, you can cancel the escrow account that holds your taxes and insurance. Many federally backed loans necessitate the establishment of an escrow account. You can ask your lender to waive the escrow requirement for a conventional loan. When you have enough equity in your home, most mortgage providers are willing to do this. You must have paid down at least 20% of your mortgage, and each lender has different requirements. There may be an escrow waiver fee, and you’ll need to make sure no property taxes or insurance payments are due in the next 30 or 60 days before canceling your escrow account.
Protection and indemnity insurance, or ‘P&I,’ is a policy purchased by ship owners to safeguard them from liability claims made by crew, passengers, and third parties. Collisions, property damage, pollution, environmental harm, and wreck removal are all examples of liability claims.
The name comes from the 1800s, when ‘Protection Clubs’ were founded to cover ship owners’ liabilities under the British Merchant Shipping Act of 1854. The Shipowners’ Mutual Protection Society, founded in 1855, was the first club to respond to these risks (latterly the Britannia Steam Ship Insurance Association). Separate Indemnity Clubs coexisted with Protection Clubs for a while, offering insurance against the then-unknown danger of cargo liability. However, in 1874, it was determined that the two would be combined to make the current shape.
Standard P&I cover
P&I insurance has two distinct characteristics. First, it is a mutual insurance, which means that the assureds are also insurers and may be required to make a supplementary contribution in the event of unusual losses that exceed their predicted premium. Second, the largest P&I insurers are members of the International Group, a claims-sharing and collective reinsurance-purchasing system. The combination of these two qualities results in liability insurance with extremely high limits (possibly around USD 7.5 billion for a single occurrence) at a reasonable price.