September 28, 2021

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How PMI works: Everything you need to know about private mortgage insurance

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Private mortgage insurance can help you buy a home without saving the traditional 20% down payment. As a concession, you pay an additional monthly premium for mortgage insurance. PMI is required for conventional, smaller down payment mortgages and can help first-time buyers become homeowners earlier.

What is PMI and how does it work?

PMI offers buyers the option to purchase a home using a traditional mortgage loan for less than what is required 20% deposit. PMI protects lenders who offer financing options with lower down payments. If you are unable to pay a 20% down payment, you consider lenders to be riskier borrowers with a higher chance that your mortgage will no longer default. In that case, the lender could use the fiduciary PMI payments you made up until late payment to offset part of their loss.

The cost of PMI

Borrowers with PMI pay an average of between 0.5% and 1.5% of the loan amount per year – or between $ 30 and $ 70 per month per $ 100,000, according to Freddie Mac. If you took out a $ 250,000 loan with a 5% down payment, PMI would add between $ 1,188 and $ 3,563 annually – or about $ 100 to $ 300 pegged to your monthly mortgage payment.

How you pay PMI, whether monthly or yearly, depends on the lender. Some may also allow you to pay a partial upfront payment upon completion, which can lower your monthly or annual PMI payments.

How to Fix a Low PMI Rate

  • Credit-worthiness: The higher your credit rating, the better your chance of getting a lower mortgage rate and PMI premium.
  • Deposit: The closer you get to a 20% deposit, the lower your PMI rate will be and the faster you can get rid of it.
  • Occupancy: Owner-occupied properties receive lower PMI rates than rental or investment properties.

When can I stop paying PMI?

PMI is typically no longer required when you have at least 20% equity in your home – whether it be from paying back the principal or increasing the value of your home.

However, some lenders may have additional requirements that you must meet before meeting your PMI obligations. These can include making a certain number of mortgage payments, getting a new estimate, or owing less than 80% of your loan amount.

Although this process can vary slightly depending on the lender, you can usually request one PMI cancellation in writing as soon as you have reached the mortgage lending threshold of 80%. You must meet certain requirements set by the Consumer Financial Protection Bureau, including:

  • A record of good payment history
  • Current loan status (not in the standard)
  • The equity may not be the subject of a subordinated loan.
  • Proof of value, if requested (obtained through appraisal).

Borrowers on Fannie Mae or Freddie Mac mortgages have a different PMI removal threshold if the mortgage is between 2 and 5 years old. These borrowers must have at least 25% equity before PMI can be terminated.

The benefits of PMI

Although PMI will add an additional cost to your monthly mortgage payments, in some cases it can be worth it. Here are some of the benefits of PMI:

  • You can buy a house sooner: For many potential homeowners, high down payment requirements make owning a home seem out of reach. With as little as 3% down payment, borrowers can buy a home sooner.
  • You can build wealth earlier: Owning a home can help you grow your wealth. Buying a home earlier using the PMI can also help you build equity faster, which in turn could help you eliminate the PMI sooner.
  • It’s only temporary costs: Once you’ve achieved an LTV rate of 80% (75% for Fannie Mae and Freddie Mac loans), you can request removal of the PMI. If you don’t request it, Lenders need to remove PMI automatically when you reach 78% LTV.
  • PMI is currently tax deductible: If you submit an individual tax return, you can currently deduct private mortgage insurance from your tax return until the end of 2021. This tax relief was revived in the Funds Commitment Act 2020 and extended in the Funds Act from January 2021 to 2021.

Disadvantages of PMI

While PMI can help you secure a mortgage with a lower down payment, there are a few drawbacks to be aware of.

  • It’s an additional bonus: No matter how low your PMI rate is, you’ll still pay an extra expense every month.
  • PMI rates can be high: PMI rates are set based on your creditworthiness, apartment occupancy, down payment amount, and equity appreciation. A high PMI rate can add more to your monthly mortgage payment than you can comfortably afford.
  • Canceling PMI takes time: You are still required to pay the PMI until the lender cancels it at 78% LTV. Often times, requesting an earlier cancellation will require you to make a formal written request that can take some time to process and remove. You may also have to pay for an appraisal if your lender requests one.

Do all home loans require PMI?

Although PMI is typically only required for conventional mortgages, other specialized mortgage types have their own version of it – with their own requirements.

  • Conventional mortgages: If you are depositing less than 20% on a traditional loan, expect to pay PMI. There are some non-PMI options out there, but these usually involve higher interest rates that could actually cost you more in the long run.
  • FHA loan: FHA loans You can take out loans with as little as 3.5% off and have a monthly insurance premium or MIP. Depending on your lender, your MIP may require prepayment on completion and then monthly or yearly payments. Borrowers with a down payment of 10% or more pay MIP for 11 years, while borrowers with less than 10% must pay for the life of the loan.
  • USDA loan: Although USDA loans do not require a down payment, they are required to have mortgage insurance Upfront and annual fees appropriate. An upfront fee of 1% of the mortgage lending value and annual fees of 0.35% annually are due upon conclusion. Although the USDA mortgage insurance cannot be canceled, it is usually cheaper than the FHA MIP and the interest rates are usually lower.
  • VA loan: There is no compulsory mortgage insurance for VA loans, but borrowers have to pay a one-time commitment fee of between 1.4 and 3.6% depending on the down payment amount. This fee can usually be included in the loan amount.
  • ARM loan: An ARM or a variable rate mortgage can also include PMI. The initial cost may be higher, but you may be able to build equity faster so you can remove the PMI faster than a fixed-rate mortgage.

Is PMI worth the effort?

There is a compromise here. PMI increases your monthly mortgage payment, but it can allow you to buy a home with a lower down payment. However, you can forego PMI by getting another type of loan, such as a USDA, VA, or conventional non-PMI loan – or saving for a larger down payment. If you choose the PMI route, compare a variety of lenders’ private mortgage insurance rates before making a commitment.