There are several financial considerations that must be made during a mortgage and homebuying situation, and one of these for many buyers is whether they’ll be required to pay private mortgage insurance. Abbreviated PMI, private mortgage insurance is a way of protecting lenders in some situations — what are these, and what are the types of PMI that may be involved in a mortgage?
At Altius Mortgage and our partners with Mortgage Ogden, we’re happy to explain any of the details of our loans to our clients, including first-time homebuyers who may not yet have a full understanding of how this area works. Let’s go over what PMI is, its various types, why you might need it, and how you can eventually get rid of it even if it’s required for you.
Private Mortgage Insurance Basics
Private mortgage insurance is essentially insurance on your ability to pay your mortgage. It’s most commonly required for borrowers who are paying less than the traditional 20% down payment toward their home — this is to protect your lender, in case you’re unable to make your scheduled payments.
PMI payments are made by homeowners themselves to the lender — but usually only for a portion of the loan term. They are typically folded in as part of your broader monthly payment, though there are other possible approaches here that we’ll go over below. In most cases, it’s possible to eventually have PMI removed; more on this in just a bit.
Types of PMI
There are actually five separate types of PMI out there:
- Buyer-paid PMI: By far the most common type, this is a form of PMI where you pay a monthly fee to offset the risk of default. As we noted above, many of these situations involve this payment being wrapped into your monthly mortgage payments. Borrowers who provide 20% down payment for their home, however, may be able to pay this fee up front; alternatively, they may be given the option of dropping it or offering other financial concessions to avoid this payment.
- Single-premium PMI: This is what we were just referring to above: With SPMI, you pay a single lump premium that counts as a closing cost. You then do not have to pay monthly PMI or any other similar fee.
- Split-premium PMI: This format mixes the two above — you’ll make a lump sum payment at closing, but then will also have to pay a monthly PMI bill. In the end, it’s a lot like SPMI. However, the monthly amounts may change if you refinance, making this a good option for many people with a high debt-to-income ratio.
- Federal Home PMI: Used for situations where borrowers are utilizing the FHA loan program, this template only requires PMI if you can’t make it to 10% of the down payment or higher. It is lifted after 11 years at minimum, or possibly sooner if you refinance. Payment format here is usually a split-premium, though there are exceptions.
- Lender-paid: Finally, a much rarer form of PMI, the lender-paid option involves the lender covering PMI, but offering significantly higher mortgage rates in exchange.
At least 80% of all homebuyers use standard buyer-paid PMI formats, one where they fold their payment into their regular monthly bill.
How PMI Works
Think of it this way: When you purchase a home, your lender is actually paying the vast majority of the bill, but it’s your rent or other housing payment that goes towards paying this off. Should you default on the loan, the lender may lose a substantial portion of what was paid out to them and can’t be recovered. It is their loss and not yours.
This is what PMI is in place to guard against. Should you default, the lender gets an insurance payout for this loss. It’s not very much money, but should help to offset their loss.
Is PMI An Absolute Requirement?
In many cases, the simple answer here is yes. There are a few situations, however, where you may be able to get by without paying regular PMI.
- FHA Loans: In many cases when utilizing the Federal Home Loan Mortgage Corporation’s FHA loan program, this will allow you to avoid monthly PMI payments if you can manage a 3.5% down payment on your home. You may need a minimum of 3.5% down from your own funds, however — this is not possible with FHA loans in all circumstances.
- With 20% Down: In the alternative, if you’re able to make a minimum 20% down payment on your home purchase, then your lender will not be taking enough risk to require PMI of you. There are virtually no cases where buyers putting down the standard 20% amount will be required to pay PMI.
Getting Rid of PMI
Luckily, in most mortgage situations, you will not be stuck paying PMI forever. Specifically, due to the Homeowner’s Protection Act, a lender is legally required to cancel PMI as soon as you’ve managed to bring your loan-to-value ratio down to 80% — that is, once you’ve reached 20% equity in your home. In many cases, you can even apply for an earlier termination of PMI if you make substantial, timely payments; this can be done on FHA loans or with conventional mortgages.
So as long as you make your payments diligently for a few years, you’ll soon be in a position where you’ll have the ability to remove part of your monthly payment that was going toward PMI.
For more on private mortgage insurance and when it’s required, or to learn about any of our mortgage rates or other home loan services, speak to the pros at Altius Mortgage today.