Private Mortgage Insurance: What You Need to Know

Many first-time homebuyers struggle with the concept of private mortgage insurance (or PMI). Understanding what it is and how it works can help you make informed decisions throughout the homebuying process. In this article, we’ll break down the basics of PMI, including why it’s required, how it’s calculated, and how to get rid of it once you no longer need it.

What is Private Mortgage Insurance?

Private mortgage insurance (PMI) is a type of insurance that lenders require you to purchase when you buy a home with less than 20% down. PMI protects the lender in case you default on your loan. Without PMI, lenders would be less likely to approve mortgages for people with low down payments, as they would be taking on more risk.

PMI is typically required until you have paid off a certain percentage of your loan (usually around 20%). This percentage is known as the loan-to-value (LTV) ratio. Once your LTV ratio drops below 80%, you may be able to cancel your PMI.

How is PMI Calculated?

The cost of PMI will depend on a few factors, including the size of your down payment and your credit score. Typically, the smaller your down payment and the lower your credit score, the more you’ll pay in PMI.

PMI is calculated based on a percentage of your loan amount. This percentage can vary depending on the lender, but it’s usually around 0.5% to 1% of the total loan amount per year. So, if you have a $200,000 loan, you could expect to pay between $1,000 and $2,000 per year in PMI.

Do I Have to Pay PMI?

If you put down less than 20% on your home, you will likely be required to pay PMI. However, there are some ways to avoid PMI:

1. Put down 20% or more.
2. Get a government-backed loan (such as an FHA loan) that has its own form of mortgage insurance.
3. Use a piggyback loan, which involves taking out two loans instead of one. The first loan covers 80% of the purchase price, while the second loan covers the remaining amount. This can help you avoid PMI, but it may come with higher interest rates.

How to Get Rid of PMI

As mentioned earlier, PMI is typically required until your LTV ratio drops below 80%. However, in some cases, you may be able to cancel your PMI earlier. Here are some ways to get rid of PMI:

Pay Down Your Loan

If you make extra payments on your mortgage, you can pay off your loan faster and reach the 80% LTV ratio sooner. Once your LTV ratio drops below 80%, contact your lender to find out how to cancel your PMI.

Get a New Appraisal

If you think your home has increased in value, you can get a new appraisal to see if your LTV ratio has fallen below 80%. If it has, contact your lender to cancel your PMI.

Refinance Your Loan

If interest rates have dropped since you first took out your mortgage, you may be able to refinance your loan to save money and get rid of PMI. However, keep in mind that refinancing comes with its own costs, so it may not be worth it if you’re close to paying off your mortgage.

FAQ

What happens if I don’t pay my PMI?

If you don’t pay your PMI, your lender may add the cost of the PMI to your monthly mortgage payment. If you still don’t pay, your lender may take legal action against you.

Can I deduct my PMI on my taxes?

You may be able to deduct your PMI on your taxes if your income falls below a certain threshold. However, this deduction is set to expire in 2021, so it may not be available for much longer.

Is PMI the same as homeowners insurance?

No, PMI is not the same as homeowners insurance. Homeowners insurance protects you in case of damage to your home, while PMI protects your lender in case you default on your loan.

Can I shop around for PMI?

Yes, you can shop around for PMI just like you can shop around for other types of insurance. It’s a good idea to get quotes from multiple lenders to make sure you’re getting the best rate.

How long does PMI last?

PMI typically lasts until your LTV ratio drops below 80%. However, if you have an FHA loan, you may be required to pay PMI for the life of your loan.

Overall, PMI is an important concept to understand if you’re planning to buy a home with less than 20% down. While it can be expensive, it allows you to become a homeowner without having to save up for a large down payment. By understanding how PMI works and how to get rid of it, you can make informed decisions about your homebuying journey and save yourself money in the long run.