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When do you need to buy private mortgage insurance?

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When you first apply for a mortgage, one of the most important questions you will need to answer is how much of a down payment can you afford to make. A higher down payment gives the lender more reassurance that you will be able to pay back the loan in the future.

That is why conventional mortgages have a 20% down payment requirement for their loans. Sure, if you cannot afford this and want to put less, you can do so, but you will have to deal with private mortgage insurance.

What is PMI?

Private mortgage insurance is a type of insurance required by conventional loan lenders for borrowers who make a down payment of less than 20% of the home’s price. PMI protects the lender in the event that the borrower stops making the mortgage and interest payments on the loan.

In the case that you default on the loan, the private mortgage insurance provider will pay back the lender. It is important to understand that PMI does not protect you from foreclosure.

The rate of PMI can vary by lender. The terms and conditions will also be decided by the lender and the private mortgage insurance provider. It is important to look through these terms carefully and find out when you will be able to stop making insurance premium payments. This usually happens when you have accumulated at least 20% equity in your home or if you have a LTV of 78%.

Cost of Private Mortgage Insurance

Private mortgage insurance rates usually range between 0.58% and 1.86% of the home’s price according to the Urban Institute. How much your private mortgage insurance premiums will cost will largely depend on several factors, such as:

Your Credit Score → the higher your credit score, the lower your premium rate will be. This is because if you have a higher credit score,  then you have shown proof that you have paid your obligations in the past. Therefore, you are perceived as less risky and less likely to default on your loan.

Loan-to-Value Ratio → the higher your Loan-to-Value ratio, the higher your premium rate will be. The Loan-to-Value ratio shows the portion of the house’s value that you borrowed from the lender. Therefore, the lower the down payment you make, the higher your Loan-to-Value ratio and the higher the cost of your PMI.

Mortgage Type → If you take an adjustable-rate mortgage, you might end up paying more in PMI. Contrary to fixed-rate mortgages which are more predictable, adjustable-rate mortgages are riskier as the rate can increase which is why a higher PMI is required.

It might be a good idea to calculate how much your PMI will cost to get a rough estimate of what you will have to pay monthly.

Types of PMI

The cost of the private mortgage insurance premiums will depend on the type of PMI you choose as well. There are generally two types of Private Mortgage Insurance:

  • Borrower-paid (BPMI) – This is the type of PMI we have been referring to so far. With a borrower-paid PMI, you have to make monthly premium payments in addition to the mortgage and interest payments. You are required to pay this monthly fee until you reach 20% of equity in your home.
  • Lender-paid (LPMI) – With this type of PMI, there is a trade-off between the monthly insurance premiums and the interest rate. Meaning that you will be charged a higher interest rate than usual in exchange for not having to pay the monthly private mortgage insurance premiums.

Benefits of Paying PMI

Even though private mortgage insurance can appear to not provide the borrower with any benefits, there are actually some upsides to paying for PMI.

First, you are able to qualify for a mortgage with a lower down payment if you pay PMI. Conventional mortgages offer down payments as low as 3% of the home’s purchase price for individuals with excellent credit history. Normally, you would have to put at least 20% down, if there was no private mortgage insurance to protect the lender.

First, you are able to qualify for a mortgage with a lower down payment if you pay PMI. Conventional mortgages offer down payments as low as 3% of the home’s purchase price for individuals with excellent credit history. Normally, you would have to put at least 20% down, if there was no private mortgage insurance to protect the lender.

In conclusion, PMI provides borrowers with the opportunity to become homeowners faster. You do not have to wait for years to save for a down payment when you can pay the monthly private mortgage insurance premiums while living in your own home. It is important to evaluate the costs and benefits that this option has to offer in order to determine the best choice for you.