When you look at your monthly mortgage payment, you will see that it is broken down into several sections. A good portion of your monthly payment goes to the principal. The interest on your loan is also thrown into the equation, along with your escrow account, which covers homeowners insurance, property taxes, and mortgage insurance.
Depending on your down payment and type of mortgage, you might also see another fee. This additional expense is known as private mortgage insurance (PMI). Your PMI payment amount will depend on the loan balance and loan to value of your loan.
The good news is that you can eventually get rid of PMI. In fact, you may even be able to ditch this extra monthly expense and reduce your mortgage payment within a few weeks.
What Is PMI or Private Mortgage Insurance?
PMI is a form of insurance that is designed to protect a lender in the event you default on your mortgage. However, you are responsible for paying PMI monthly premiums, which is why this expense is included in your mortgage payment.
Why Do Lenders Require PMI?
When a lender loans you money to buy a home, it incurs a certain level of risk. The amount of risk depends on several factors, such as your credit score, your repayment history, and the total amount you are borrowing. Another major factor that lenders use to assess risk is the percentage of the home purchase that you are financing.
Let’s say that you want to purchase a $300,000 home and are able to pay closing costs and put $60,000 down. In this scenario, you would finance the remaining $240,000, which is 80% of the home’s value.
The lender is not taking on excessive risk in this scenario. Suppose that the worst happens, and you can no longer make payments. If the bank forecloses on the loan, it will still be able to recoup its money lent to you — even if the home’s value drops below $300,000 based on the “equity position” from the 20% down payment.
However, say that you are only able to put down $30,000, or 10% of the home’s value. In this case, you would finance 90% of the home. Under these circumstances, the lender would be taking on a bit more risk. If you default on the loan, it will be harder for the lender to recoup all of the money lent to you.
That’s where private mortgage insurance (PMI) comes into play. PMI is required if you finance more than 80% of the home’s appraised value. If you put 20% or more down on your home purchase, you do not need PMI.
Does PMI Differ by Loan Type?
Yes, PMI requirements differ by loan type. Here is a breakdown of PMI requirements for the four most common types of mortgages:
Conventional Loan PMI
PMI terms for conventional loans are very straightforward. If you finance more than 80% of the home’s value, you will need PMI. If you don’t, you won’t.
Even if you have to take on a PMI payment, you won’t have it forever. PMI will automatically be removed from your monthly mortgage payment after your loan amount reaches 78% of the home’s appraised value.
You can request PMI cancellation as soon as you reach the 80% mark, but your lender will not remove it at this point unless you explicitly ask for it.
FHA Loan MIP
If you take on an FHA loan, this expense will be called a mortgage insurance premium (MIP). It is essentially the same, but unlike conventional loan PMI, FHA MIP does not fall off on its own unless you put 10% down and make payments for 11 years.
If you purchase a home using an FHA loan, you will pay this premium for the life of the loan. Unfortunately, FHA MIP payments are usually a bit higher than conventional loan premiums, which means that you could pay up to several hundred dollars a month.
However, you can get rid of your FHA MIP by refinancing after you have hit the required threshold. You can remove this expense if you refinance into a conventional loan — as long as you have at least 20% equity.
VA Loan PMI
VA loans are great mortgage options that are available to active and former members of the U.S. Military. These loans include many favorable terms, including a PMI exemption. If you purchase a home using a VA loan, you will not have to pay for PMI, no matter what percentage of the home’s value you finance.
USDA Loan PMI
USDA loans are available to buyers seeking to purchase property in designated rural areas. These loans have favorable terms, such as a relatively low interest rate and a $0 money down requirement. USDA loans are also exempt from the PMI requirement, however, the borrower will pay an annual guarantee fee which will be paid monthly with their mortgage payment much like PMI.
In order to qualify for a USDA loan, you need to meet strict lending requirements. You must have a minimum credit score and fall under the program’s income limits. The property must also be located in a rural community, as defined by the USDA.
How to Calculate PMI
Many factors influence your total PMI payment, including your debt-to-income ratio, your credit score, the home’s total value, and how much money you are putting down. While you will have to pay PMI whether you put 3% down or 18% down, the closer you are to that 20% mark, the lower your PMI will be.
Your annual PMI costs will range from 0.1% to 2% of the total loan amount. For instance, if you borrow $270,000, your payments could be as high as $5,400 annually, or roughly $450 per month. Or they could be as low as $270 annually — a little over $20 per month.
Keep in mind that PMI payments are rarely at the extreme ends of this range. In the above example, you can expect to pay between $150 and $300 per month.
If you are already working with a lender, the lender should be able to provide a more accurate PMI estimate.
Do You Have to Refinance to Get Rid of PMI?
If you have an FHA loan, then yes, you will have to refinance to get rid of mortgage insurance. Otherwise, these payments will remain a part of the loan permanently.
If you have a conventional loan, you can wait until your mortgage balance reaches 78% of the original value of your home. When assessing whether to remove PMI, lenders generally use the original value of your home at the time of purchase.
Some lenders will remove PMI if you can show that your home has risen in value and that you now have at least 20% equity. In that case, you might pay for a professional appraisal to prove your home’s new value to your lender.
Refinancing can also allow you to drop PMI sooner. If you refinance your home, the lender will conduct a new appraisal and use this value to determine whether PMI is required.
Your home value has probably increased significantly since you originally purchased it, especially if you bought your house before the recent market spike or if you have made a large principal reduction. This means you might be able to drop PMI now, so long as the appraisal indicates that you have at least 20% equity in your home.
Ways to Eliminate PMI
Here are three ways to eliminate PMI:
- Making payments until PMI automatically cancels
- Asking for removal when equity is 20% or higher
- Make a large principal reduction to reduce your loan balance to 80% and ask for removal
- Getting a new appraisal if your house has increased in value
Remember, these strategies only work with conventional loans and might not be applicable to other loan types.
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