5 Types of Private Mortgage Insurance (PMI)

If you are purchasing a home with a down payment of less than 20%, it is critical that you understand your options for private mortgage insurance (PMI). Some people simply cannot afford to make a 20% down payment. Others may choose to make a smaller down payment in order to have more cash on hand for repairs, remodeling, furniture, and emergencies.

What Is Private Mortgage Insurance (PMI)?

A borrower may be required to purchase private mortgage insurance (PMI) as a condition of obtaining a conventional mortgage loan. When a homebuyer makes a down payment of less than 20% of the purchase price, most lenders require PMI.

When a borrower makes a down payment of less than 20% of the property's value, the loan-to-value (LTV) ratio of the mortgage exceeds 80%. (the higher the LTV ratio, the higher the risk profile of the mortgage for the lender).

The policy, unlike most types of insurance, protects the lender's investment in the home rather than the individual purchasing the insurance (the borrower). However, PMI enables some people to become homeowners sooner. Individuals who choose to put down 5% to 19.99% of the purchase price of a home can obtain financing through PMI.

It does, however, have additional monthly costs. Borrowers must continue to pay PMI until they have built up enough equity in their home that the lender no longer considers them high-risk.

Depending on the size of the down payment and mortgage, the loan term, and the borrower's credit score, PMI costs can range from 0.5% to 2% of the loan balance per year. The higher your risk factors, the higher your rate. Because PMI is calculated as a percentage of the loan amount, the more you borrow, the more PMI you'll have to pay. In the United States, there are several major PMI firms. They charge comparable rates that are adjusted annually.

While PMI is an additional expense, so is continuing to pay rent and possibly missing out on market appreciation while saving for a larger down payment. However, there is no guarantee that buying a home later rather than sooner will result in a profit, so the value of paying PMI is worth considering.

Some prospective homeowners may require Federal Housing Administration (FHA) mortgage insurance. That is, however, only if you qualify for a Federal Housing Administration loan (FHA loan).

Private Mortgage Insurance (PMI) Coverage

You should first understand how PMI works. Assume you put down 10% and get a loan for the remaining 90% of the property's value—$20,000 down and a loan for $180,000. Mortgage insurance limits the lender's losses if the lender has to foreclose on your mortgage. This could occur if you lose your job and are unable to make your payments for several months.

A certain percentage of the lender's loss is covered by the mortgage insurance company. Let's say that percentage is 25% in our example. So, if you still owed 85% ($170,000) of your home's $200,000 purchase price when you were foreclosed on, the lender would only lose 75% of $170,000, or $127,500, on the home's principal. The remaining 25%, or $42,500, would be covered by PMI. It would also pay for 25% of your delinquent interest and 25% of the lender's foreclosure costs.

You may be wondering why the borrower must pay for PMI if it protects the lender. In essence, the borrower is compensating the lender for taking on the higher risk of lending to you rather than lending to someone who is willing to put down a larger down payment.

How Long Do You Have to Buy Private Mortgage Insurance (PMI)?

Borrowers can ask for their monthly mortgage insurance payments to be waived once their loan-to-value ratio falls below 80%. As long as you're current on your mortgage and the LTV ratio falls below 78%, the lender must automatically cancel PMI. This occurs when your down payment plus loan principal paid equals 22% of the home's purchase price. This cancellation is required by the federal Homeowners Protection Act, even if the market value of your home has decreased.

Types of Private Mortgage Insurance (PMI)

1. Borrower-Paid Mortgage Insurance

Borrower-paid mortgage insurance is the most common type of PMI (BPMI). BPMI is paid as an additional monthly fee in addition to your mortgage payment. After your loan is closed, you will pay BPMI on a monthly basis until you have 22% equity in your home (based on the original purchase price).

As long as you're current on your mortgage payments, the lender must automatically cancel BPMI. It usually takes about 15 years to build up enough home equity through regular monthly mortgage payments to get BPMI canceled.

When you have 20% equity in your home, you can also be proactive and ask the lender to cancel BPMI. Your mortgage payments must be current for your lender to cancel BPMI. There must also be no additional liens on your property and a satisfactory payment history. In some cases, a current appraisal may be required to prove the value of your home.

Some loan servicers may allow borrowers to cancel PMI sooner if their home's value rises. Assume the borrower accumulates 25% equity in years two through five due to appreciation, or 20% equity after year five. In that case, the investor who purchased the loan may allow PMI cancellation after the increased value of the home is demonstrated. This can be accomplished through the use of an appraisal, a broker's price opinion (BPO), or an automated valuation model (AVM).

You may also be able to avoid PMI by refinancing. However, the cost of refinancing must be balanced against the cost of continuing to pay mortgage insurance premiums. You may also be able to cancel your PMI sooner if you pay off your mortgage principal early enough to have at least 20% equity.

If you're willing to pay PMI for up to 15 years to buy now, it's worth considering. What will PMI ultimately cost you? What could you lose by delaying your purchase? While you may miss out on accumulating home equity while renting, you will also avoid the many costs associated with homeownership. Homeowner's insurance, property taxes, maintenance, and repairs are among the expenses.

Borrower-paid mortgage insurance is far more common than the other three types of PMI. You may still want to understand how they work if one of them sounds more appealing to you or if your lender offers you more than one mortgage insurance option.

2. Single-Premium Mortgage Insurance

You pay mortgage insurance upfront in a lump sum with single-premium mortgage insurance (SPMI), also known as single-payment mortgage insurance. This can be done in full at closing or as part of the mortgage (in the latter case, it may be called single-financed mortgage insurance).

The advantage of SPMI over BPMI is that your monthly payment will be lower. This can help you qualify for a larger loan to purchase a home. Another advantage is that you do not need to refinance to get out of PMI. You also don't have to keep an eye on your loan-to-value ratio to see when you can cancel your PMI.

The risk is that no portion of the single premium is refundable if you refinance or sell within a few years. Furthermore, if you finance the single premium, you will pay interest on it for the duration of the mortgage. Furthermore, if you don't have enough money for a 20% down payment, you might not be able to pay a single premium upfront.

However, in the case of a new home, the seller or builder can pay the borrower's single-premium mortgage insurance. You can always try to work that into your purchase offer.

Single-premium mortgage insurance may save you money if you plan to stay in your home for three or more years. Check with your loan officer to see if this is the case. Keep in mind that not all lenders provide single-premium mortgage insurance.

3. Lender-Paid Mortgage Insurance

Your lender will technically pay the mortgage insurance premium with lender-paid mortgage insurance (LPMI). In fact, you will pay for it in the form of a slightly higher interest rate over the life of the loan.

LPMI, unlike BPMI, cannot be canceled once your equity reaches 78% because it is built into the loan. Only refinancing will allow you to reduce your monthly payment. Once you have 20% or 22% equity, your interest rate will not be reduced. PMI paid by the lender is not refundable.

Despite the higher interest rate, the benefit of lender-paid PMI is that your monthly payment may still be lower than making monthly PMI payments. As a result, you may be able to borrow more money.

4. Split-Premium Mortgage Insurance

The least common type is split-premium mortgage insurance. It's a cross between the first two types we talked about: BPMI and SPMI.

The way it works is that you pay part of the mortgage insurance up front and part monthly. You don't have to put up as much money up front as you would with SPMI, nor do you have to increase your monthly payment as much as you would with BPMI.

If you have a high debt-to-income ratio, you should consider split-premium mortgage insurance. In that case, increasing your monthly payment too much with BPMI would result in you not being able to borrow enough to buy the home you want.

The initial premium could range between 0.50% and 1.25% of the loan amount. The monthly premium will be calculated using the net loan-to-value ratio before any financed premium is taken into account.

You can ask the builder or seller to pay the initial premium, as with SPMI, or you can roll it into your mortgage. Once mortgage insurance is canceled or terminated, split premiums may be partially refunded.

5. Federal Home Loan Mortgage Protection (MIP)

There is another kind of mortgage insurance. It is, however, only used with loans guaranteed by the Federal Housing Administration. These loans are more commonly referred to as FHA loans or FHA mortgages. MIP is the FHA's term for private mortgage insurance. It is mandatory for all FHA loans with down payments of 10% or less.

Furthermore, it cannot be removed unless the home is refinanced. MIP requires a one-time payment as well as monthly premiums (usually added to the monthly mortgage note). If the buyer put down more than 10%, they must still wait 11 years before they can remove the MIP from the loan.

Cost of Private Mortgage Insurance (PMI)

The cost of your PMI premiums will be determined by a number of factors.

• Which premium plan you choose
• Whether or not your interest rate is fixed or variable
• 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 required by the lender or investor (it can range between 6% and 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, should be considered.

In general, the riskier you appear based on any of these factors (which are usually considered when taking out a loan), the higher your premiums will be. For example, if you have a low credit score and a low down payment, your premiums will be higher.

According to Ginnie Mae and the Urban Institute data, the average annual PMI ranges from.55% to 2.25% of the original loan amount. Here are some examples: If you put down 15% on a 15-year fixed-rate mortgage with a credit score of 760 or higher, you'd pay 0.17% because you'd be considered a low-risk borrower. If you put down 3% on a 30-year adjustable-rate mortgage with a three-year fixed introductory rate and have a credit score of 630, your rate will be 2.81%. This is because most financial institutions would consider you a high-risk borrower.

Once you've determined which percentage applies to your situation, multiply it by the amount borrowed. Then divide that total by 12 to determine your monthly payment. A $200,000 loan with an annual premium of 0.65%, for example, would cost $1,300 per year ($200,000 x.0065), or about $108 per month ($1,300 / 12).

Estimating Rates for Private Mortgage Insurance (PMI)

Mortgage insurance is available from a variety of companies. Their rates may differ slightly, and the insurer will be chosen by your lender, not you. Nonetheless, by studying the mortgage insurance rate card, you can get an idea of what rate you will pay. Major private mortgage insurance providers include MGIC, Radian, Essent, National MI, United Guaranty, and Genworth.

At first glance, mortgage insurance rate cards can be perplexing. Here's how to put them to use.

1. Locate the column corresponding to your credit score.
2. Locate the row corresponding to your LTV ratio.
3. Determine the appropriate coverage line. To determine how much coverage is required for your loan, lookup Fannie Mae's Mortgage Insurance Coverage Requirements on the internet. You can also inquire with your lender (and impress the pants off them with your knowledge of how PMI works).
4. Determine the PMI rate based on the intersection of your credit score, down payment, and coverage.
5. If applicable, add or subtract the amount from the adjustment chart (below the main rate chart) that corresponds to your credit score from that rate. For example, if you're doing a cash-out refinance and have a credit score of 720, you might add 0.20 to your interest rate.
6. As we demonstrated in the previous section, multiply the total rate by the amount borrowed to calculate your annual mortgage insurance premium. Divide the total by 12 to calculate your monthly mortgage insurance premium.

Your monthly rate will be the same, though some insurers will reduce it after ten years. However, that is just before you should be able to drop coverage, so any savings will be minimal.

Federal Housing Administration (FHA) Mortgage Insurance

With FHA loans, mortgage insurance works differently. It will end up being more expensive than PMI for the vast majority of borrowers.

Unless you choose single-premium or split-premium mortgage insurance, you do not have to pay an upfront premium for PMI. You will not pay monthly mortgage insurance premiums if you have single-premium mortgage insurance. Because you paid an upfront premium for split-premium mortgage insurance, you pay lower monthly mortgage insurance premiums. With FHA mortgage insurance, however, everyone must pay an upfront premium. Furthermore, that payment has no effect on your monthly premiums.

The upfront mortgage insurance premium (UFMIP) is 1.75% of the loan amount as of 2021. This amount can be paid at closing or financed as part of your mortgage. For every $100,000 borrowed, the UFMIP will cost you $1,750. If you finance it, you'll also have to pay interest, which makes it more expensive over time. If the seller's total contribution to your closing costs does not exceed 6% of the purchase price, the seller may pay your UFMIP.

You'll also have to pay a monthly mortgage insurance premium (MIP) of 0.45% to 1.05% of the loan amount, depending on your down payment and loan term. According to the FHA table below, if you have a $200,000 30-year loan and pay the FHA's minimum down payment of 3.5%, your MIP will be 0.85% for the life of the loan. It can be costly to be unable to cancel your MIPs.

After 15 years, you can cancel your monthly MIPs on FHA loans with a down payment of 10% or more. But, if you have a 10% down payment, why get an FHA loan at all? You should only do this if your credit score is insufficient to qualify for a conventional loan. Another compelling reason is that your low credit score would result in a significantly higher interest rate or PMI expense with a traditional loan than with an FHA loan.

An FHA loan can be obtained with a credit score as low as 580, and possibly even lower (though lenders might require your score to be 620 or higher). In addition, you may be able to get the same interest rate on a conventional loan despite having a lower credit score: 660 versus 740, for example.

The only way to stop paying FHA MIPs without putting down 10% or more on an FHA mortgage is to refinance into a conventional loan. This step will make the most sense after your credit score or LTV has significantly increased. However, refinancing entails paying closing costs, and interest rates may be higher when you're ready to refinance. Higher interest rates, combined with closing costs, may cancel out any savings from canceling FHA mortgage insurance. Furthermore, you cannot refinance if you are unemployed or have an excessive amount of debt in relation to your income.

Furthermore, FHA loans allow sellers to contribute to the buyer's closing costs up to 6% of the loan amount, versus 3% for conventional loans. If you can't afford to buy a home without significant down payment assistance, an FHA loan may be your only option.

The Bottom Line

Borrowers must pay for mortgage insurance, but it allows them to become homeowners sooner by lowering the risk to financial institutions of issuing mortgages to people with low down payments. If you want to own a home sooner rather than later for lifestyle or affordability reasons, you may find it worthwhile to pay mortgage insurance premiums. In addition, if you're paying monthly PMI or split-premium mortgage insurance, premiums can be canceled once your home equity reaches 80%.

However, if you are one of the borrowers who must pay FHA insurance premiums for the life of the loan, you should reconsider. You may be able to refinance out of an FHA loan later to avoid paying PMI. However, there is no guarantee that your employment situation or market interest rates will allow or profit from a refinance.