What You Need to Know About Private Mortgage Insurance (PMI)

Buying a home is an exciting experience, but it can also be overwhelming, especially when it comes to understanding the various financial obligations that come with homeownership. One of the more confusing aspects of home buying is private mortgage insurance, or PMI. PMI is often required by lenders when a borrower puts down less than 20% on a home purchase. In this article, we’ll cover what you need to know about PMI, including what it is, how it works, and how you can avoid it.

What is Private Mortgage Insurance (PMI)?

Private mortgage insurance (PMI) is an insurance policy that protects lenders in the event that a borrower defaults on their mortgage payments. PMI is typically required by lenders when a borrower makes a down payment of less than 20% of the home’s purchase price. The insurance policy is meant to mitigate the lender’s risk and ensure that they are able to recoup their losses in the event of a foreclosure.

PMI is not the same as homeowners insurance, which is a separate policy that protects the homeowner in the event of damage to the property. Private mortgage insurance (PMI) is strictly for the benefit of the lender and does not provide any protection for the homeowner.

How Does PMI Work?

PMI is typically added to the borrower’s monthly mortgage payment and is paid until the loan-to-value (LTV) ratio reaches 78%. The LTV ratio is the amount of the loan compared to the appraised value of the property. For example, if a borrower purchases a home for $300,000 and puts down 10%, or $30,000, the loan amount would be $270,000. If the home is appraised at $300,000, the LTV ratio would be 90% ($270,000 / $300,000).

The borrower’s monthly private mortgage insurance (PMI) payment is based on a percentage of the loan amount, typically ranging from 0.3% to 1.5% annually. Using the same example as above, if the PMI rate is 0.5%, the borrower would pay $112.50 per month ($270,000 x 0.5% / 12).

Once the LTV ratio reaches 78%, the borrower can request that the PMI be removed from their monthly mortgage payment. The lender is required by law to remove the PMI when the LTV ratio reaches 78% based on the original appraised value of the home. However, the borrower can also request that the private mortgage insurance (PMI) be removed when the LTV ratio reaches 80% based on the current value of the home. In order to have the PMI removed, the borrower must have a good payment history and may need to provide an appraisal showing the current value of the home.

It’s important to note that FHA loans have different rules regarding private mortgage insurance (PMI). FHA loans require PMI for the life of the loan, regardless of the loan-to-value ratio. The only way to remove PMI on an FHA loan is to refinance the loan.

Why Do Lenders Require PMI?

Lenders require private mortgage insurance (PMI) when a borrower makes a down payment of less than 20% because it increases their risk. When a borrower puts down less than 20%, they have less equity in the home, which means they have less of a financial stake in the property. If the borrower defaults on their mortgage payments and the lender forecloses on the property, the lender may not be able to recoup their losses if the sale of the property does not cover the outstanding mortgage balance. PMI provides an additional layer of protection for lenders in the event of a foreclosure.