It’s important to have a relative understanding of what Private Mortgage Insurance (PMI) is when you are in the final steps of the mortgage approval process.
Here is some information to learn what PMI is, how much it costs, and how to avoid or get rid of it.
What is Private Mortgage Insurance?
Private mortgage insurance, also known as PMI, is something that lenders often require from borrowers who are making a down payment less than 20%.
PMI insures lenders in the event that a borrower defaults on the payments. But it also allows lenders to make homeownership an option for home buyers who do not have the cash for the standard down payment.
Borrowers have two PMI payment options. Most homeowners choose to include PMI as part of their monthly payments, but others can pay it up front instead.
Some lenders also offer “lender-paid” mortgage insurance, meaning they pay for your mortgage insurance up front, and you repay them every month with a slightly higher interest rate.
How Much Does PMI Cost?
Private Mortgage Insurance is determined by your total loan amount and mortgage insurance rate. Typically, PMI cost ranges from 0.5% to 1.0% of the total loan amount on an annual basis.
But, your own personal PMI rate will depend on various factors, such as your credit score, income, and loan-to-value ratio.
Here are a few factors to keep in mind:
- Down payment %: The higher your down payment, the lower your mortgage insurance payment.
- Credit score: The higher your credit score, the lower your mortgage insurance payment. Your PMI will be the lowest if you have a credit score above 760.
- Debt-to-income ratio: Your DTI ratio is your total monthly debt payments divided by your gross monthly income. If your DTI is above the 45% threshold, your PMI may cost more.
- Number of borrowers: If you have more than one borrower on your mortgage, your PMI will be cheaper. Lenders feel more secure knowing that there are at least two people that are now responsible for the loan.
When Does PMI Stop?
The Homeowners Protection Act of 1998 states that your Private Mortgage Insurance payments will automatically end once you reach 22% equity in your home. Or, if you choose to, you can request a cancellation at 20% equity based on your original property value.
Keep in mind that FHA loans require a different mortgage insurance and it won’t be able to be removed. It’s there to stay for the life of the loan. So, if you’re looking to avoid these potential long-term costs, the HomeReady program may be a good alternative to look into.
Can I Avoid PMI Altogether?
The simplest way to avoid Private Mortgage Insurance altogether is by making the minimum down payment of 20%. Lenders usually require mortgage insurance for loans that exceed 80% of the property’s sale price.
Of course, it’s not always easy to save up enough for a 20% down payment. So, the other option is to take out a second mortgage to cover anything over the 80% that your down payment does not.