Last Updated on November 6, 2023 by SPN Editor
Private Mortgage Insurance (PMI) is a financial safeguard that often gets overlooked in the excitement of purchasing a new home. It’s a safety net for lenders when borrowers make a down payment of less than 20% of the home’s purchase price. In the United States, Private Mortgage Insurance is a common addition to mortgage agreements, impacting nearly one in five borrowers.
The Purpose of Private Mortgage Insurance
PMI is fundamentally designed to protect the financial interests of lenders and mortgage investors in case you, the borrower, default on your loan. While the insurance is essential for lenders, it’s typically the borrower who foots the bill.
There is another option known as lender-paid mortgage insurance, but in most cases, the lender incorporates the costs into the loan amount, offering no financial advantage to the borrower. Private Mortgage Insurance can be a substantial expense, often accounting for as much as 2% of the loan amount. Given this, if you’re responsible for PMI payments, it’s essential to explore the avenues to rid yourself of this extra financial burden as quickly as possible.
Your Path to Private Mortgage Insurance Freedom
One option is to do nothing but make your regular monthly payments. Private Mortgage Insurance is automatically canceled when you reach either 22% equity in the home, based on the original loan value, or when you reach the halfway point of your loan term. Your lender can precisely pinpoint when you’ll reach the 22% equity mark, and this date should be outlined in your loan documentation.
If you can’t locate it, a simple inquiry to your lender will provide the necessary information. However, it’s vital to emphasize that waiting for PMI to automatically vanish might be the costliest option in the long run.
- Premium Plan Choice: Your PMI premium expenses are directly tied to the type of premium plan you select. The specific plan you opt for can have varying structures and payment requirements.
- Interest Rate Type: Whether your mortgage interest rate is fixed or adjustable plays a role in determining PMI costs. Fixed rates provide stability, while adjustable rates may introduce more uncertainty.
- Loan Term: The duration of your loan, typically 15 or 30 years, affects PMI costs. Longer-term loans may entail higher cumulative PMI payments.
- Down Payment or Loan-to-Value Ratio (LTV): Your initial down payment, expressed as a percentage, establishes your Loan-to-Value ratio (LTV). For instance, a 5% down payment results in a 95% LTV, while a 10% down payment yields a 90% LTV. A lower LTV often leads to lower PMI costs.
- Required Insurance Coverage: The amount of mortgage insurance coverage stipulated by your lender or investor can span a wide range, from 6% to 35% of the loan amount. Greater coverage translates to higher premiums.
- Refundable Premiums: PMI premiums may or may not be refundable. The refundability factor can influence the overall cost of your mortgage insurance.
- Credit Score: Your credit score is a pivotal determinant of PMI costs. Higher credit scores tend to result in more favorable PMI rates, while lower scores may lead to higher premiums.
- Risk Factors: Additional risk factors related to the nature of your loan can impact PMI costs. These factors encompass the type of mortgage (e.g., jumbo), whether it’s an investment property, a cash-out refinance, or a second home.
The more risk factors that are associated with your mortgage, the higher your Private Mortgage Insurance premiums are likely to be. A lower credit score or a minimal down payment can elevate your premiums. Conversely, a larger down payment and an excellent credit score tend to work in your favor, potentially lowering the overall cost of your PMI.
Types of Private Mortgage Insurance (PMI)
When you’re stepping into the realm of homeownership, understanding mortgage insurance is an essential part of the journey. Mortgage insurance, often known as Private Mortgage Insurance (PMI), comes in various forms, each with its own nuances and considerations. In this article, we’ll explore the different types of mortgage insurance and the factors you should weigh when deciding which one aligns with your homeownership goals.
Borrower-Paid Mortgage Insurance (BPMI)
The most prevalent form of Private Mortgage Insurance is Borrower-Paid Mortgage Insurance (BPMI). With BPMI, a borrower incurs an additional monthly fee that is bundled into their regular mortgage payment. This continues until the borrower attains 22% equity in their home, based on the original purchase price. Typically, it takes around 15 years of consistent monthly payments to reach this point.
Proactive borrowers can request the cancellation of BPMI when they reach 20% equity in their home, provided they maintain a current payment history and have no additional liens on their property. In some cases, a current appraisal might be required to validate the home’s current value.
Single-Premium Mortgage Insurance (SPMI)
Single-Premium Mortgage Insurance (SPMI), also known as single-payment mortgage insurance, deviates from the monthly premium model. Borrowers pay a lump sum upfront either at closing or by financing it into the mortgage (referred to as single-financed mortgage insurance). The advantage of SPMI is that it results in lower monthly payments compared to BPMI. This can enable borrowers to qualify for higher loan amounts and eliminates the need for refinancing to remove Private Mortgage Insurance.
However, there are risks associated with SPMI. If you refinance or sell your home within a few years, there’s usually no refund for the upfront premium. Additionally, if you finance the single premium, you’ll pay interest on it for the duration of the mortgage. The hurdle here is that not everyone can afford to pay a single premium upfront. Sellers or builders might also consider covering the borrower’s single-premium mortgage insurance, a negotiable point in purchase agreements.
Lender-Paid Mortgage Insurance (LPMI)
Lender-Paid Mortgage Insurance (LPMI) offers an alternative approach. In this scenario, the lender pays the mortgage insurance premium on behalf of the borrower. However, this expense is essentially built into the loan and repaid by the borrower through a slightly higher interest rate over the life of the loan.
Unlike BPMI, LPMI cannot be canceled when equity reaches 78%. Refinancing remains the sole method to reduce the monthly payment. The interest rate will not decrease when reaching 20% or 22% equity, and LPMI is non-refundable. Despite the higher interest rate, monthly payments may still be lower, potentially allowing borrowers to qualify for higher loan amounts.
Split-Premium Mortgage Insurance
Split-Premium Mortgage Insurance combines elements of BPMI and SPMI. With this approach, borrowers pay a portion of the mortgage insurance premium as a lump sum at closing and the remainder in monthly installments. This hybrid model doesn’t require as much upfront cash as SPMI and doesn’t inflate monthly payments as significantly as BPMI.
Borrowers with high debt-to-income ratios might find split premiums beneficial as BPMI could hinder their ability to qualify for the desired home purchase. The upfront premium typically ranges from 0.50% to 1.25% of the loan amount, and the monthly premium is based on the net loan-to-value ratio. In certain cases, a portion of the split premium may be refundable upon the cancellation or termination of mortgage insurance.
Federal Home Loan Mortgage Protection (MIP)
Federal Home Loan Mortgage Protection, or MIP, is distinct and is associated with loans underwritten by the Federal Housing Administration (FHA). Typically, MIP is a requirement for all FHA loans, especially when down payments are less than 10%. Unlike other forms of Private Mortgage Insurance, MIP cannot be removed without refinancing the home. It necessitates an upfront payment and monthly premiums that are often added to the monthly mortgage note. If the down payment exceeds 10%, borrowers must wait 11 years before MIP can be removed from the loan.
Taking Control: Faster Paths to PMI Elimination
There are several proactive strategies to accelerate the removal of Private Mortgage Insurance from your mortgage:
- Appreciation: Your home’s value is not static; it can change over time due to various factors. Consider improvements to your property or the influence of market conditions in your neighborhood. If your home’s value increases, your equity also grows. When this results in reaching 20% equity or more, you can contact your lender and request the cancellation of Private Mortgage Insurance on your mortgage. Not only will this lead to an earlier end to your PMI payments, but it also provides a lower target equity percentage, bypassing the 22% requirement.
- Paying Aggressively: Another effective method for shedding Private Mortgage Insurance sooner is to make extra payments towards your mortgage. Many lenders permit borrowers to split their payments into bi-monthly installments, essentially making an additional annual payment. Moreover, some lenders offer the option to contribute extra funds toward the loan’s principal each month. By aggressively paying down your mortgage, you can reach the 20% or 22% equity threshold more rapidly, qualifying for PMI removal either through a reappraisal process or the automatic cancellation metric.
- Refinancing: The final avenue to escape Private Mortgage Insurance is through mortgage refinancing, especially when your home’s value has seen a significant increase. Refinancing involves taking out a new mortgage to pay off your existing one. If your home’s value has appreciated, you might refinance for an amount greater than your current loan balance. This excess cash can be used to settle your existing mortgage and eliminate Private Mortgage Insurance.
In some cases, you can even explore a “PiggyBack” mortgage strategy, which entails two mortgages to circumvent the 20% equity rule that typically triggers PMI. One mortgage covers 80% of the total loan amount, while the remainder is divided between a second, smaller mortgage and your down payment.
While PMI can indeed inflate your monthly mortgage expenses, it’s not a financial anchor you’re stuck with indefinitely. By taking action, whether through requesting PMI cancellation, capitalizing on appreciation, making extra payments, or refinancing, you can chart a course to free yourself from this additional cost. Remember that maintaining a good payment history, staying current on your mortgage, and meeting lender requirements are crucial for any Private Mortgage Insurance elimination strategy.