Private Mortgage Insurance Definition: What You Need to Know

If you’re planning to buy a home soon and don’t have enough money for a down payment, private mortgage insurance (PMI) might be what you’re looking for. PMI is a type of insurance that protects a lender in case a borrower defaults on their mortgage payments.

How Does PMI Work?

When you apply for a mortgage, lenders usually require a down payment of at least 20% of the home’s purchase price. If you can’t afford that and put down less than 20%, the lender may require you to get PMI.

PMI is typically a monthly payment that you make along with your mortgage payment. The amount you pay depends on the size of your down payment, the amount of your loan, and your credit score. PMI can cost anywhere from 0.3% to 1.5% of the original loan amount per year.

The insurance protects the lender, not the borrower. If you default on your loan, the lender can file a claim with the insurance company to recover some of its losses. This is why lenders are willing to approve loans with smaller down payments when PMI is required.

Example:

Let’s say you want to buy a home for $300,000 but only have $30,000 for a down payment, which is 10% of the purchase price. The lender requires you to get PMI because your down payment is less than 20%. The PMI rate is 1% per year, so you would pay $250 a month in PMI.

Types of PMI

There are two types of PMI: borrower-paid and lender-paid. Here’s how they work:

Borrower-Paid PMI

Borrower-paid PMI is the most common type of PMI. As the name suggests, the borrower pays for the insurance. This is usually done as a monthly payment, but some lenders allow borrowers to pay the entire amount upfront.

Borrower-paid PMI can be cancelled once the borrower has paid off a certain percentage of the loan or the home’s value has increased enough to create at least 20% equity. This is typically done by requesting a new appraisal of the home.

It’s important to note that not all loans with borrower-paid PMI can be cancelled. Some loans, such as those backed by the Federal Housing Administration (FHA), require PMI for the life of the loan.

Lender-Paid PMI

Lender-paid PMI is less common than borrower-paid PMI. In this case, the lender pays for the insurance but charges a higher interest rate on the loan to compensate for the cost of the insurance.

This type of PMI cannot be cancelled by the borrower. However, some lenders may allow the borrower to refinance the loan to get rid of the PMI.

FAQ

Do I Need PMI?

If your down payment is less than 20% of the home’s purchase price, your lender will likely require you to get PMI. However, some lenders may allow you to avoid PMI by taking out a second loan to cover the remaining balance.

How Much Does PMI Cost?

The cost of PMI varies depending on the size of your down payment, the amount of your loan, and your credit score. PMI can cost anywhere from 0.3% to 1.5% of the original loan amount per year.

How Do I Cancel PMI?

If you have borrower-paid PMI, you can usually cancel it once you’ve paid off a certain percentage of the loan or the home’s value has increased enough to create at least 20% equity. This is typically done by requesting a new appraisal of the home.

If you have lender-paid PMI, you cannot cancel it. However, some lenders may allow you to refinance the loan to get rid of the PMI.

Can I Get PMI Refunded?

If you’ve paid for PMI and cancel it before the end of the loan term, you may be entitled to a refund of some of the premiums you paid. However, this varies by lender and loan type.

Conclusion

Private mortgage insurance is an important tool that can help you buy a home with a smaller down payment. Borrower-paid PMI can be cancelled once you’ve paid off a certain percentage of the loan or the home’s value has increased enough to create at least 20% equity. Lender-paid PMI cannot be cancelled, but some lenders may allow you to refinance the loan to get rid of the PMI. As with any financial decision, it’s important to do your research and understand the terms of your loan before signing on the dotted line.