Knowing Your Mortgage Insurance Options (Conventional Loan PMI)

Knowing Your Mortgage Insurance Options ?

Most mortgage options will require that you purchase private mortgage insurance when purchasing a home with less than 20% down, so it's important to understand the basics. As with any purchase, you should have an idea of what you're looking for and at what cost.

Private Mortgage Insurance is a type of coverage that protects the lender from losing money if a borrower defaults on their home loan payments. It's a common misconception that Private Mortgage Insurance (PMI) would serve to protect the borrower, as it's name admittedly implies. In reality, it actually is intended to protect the lender from financial loss if the buyer cannot (...or does not) pay their mortgage.

Here's the good news/bad news: We don't write lending laws, we just write about them. So, while PMI is often a necessary evil of home buying, we'll fill you in on the basics of Private Mortgage Insurance, how to save the most, and how you can eliminate it completely with a little time or money on your side.

The Five Types of Private Mortgage Insurance

There are five different types of PMI, which range in price depending on its type and coverage amount: Lender Paid Mortgage Insurance (LPMI), Borrower Paid Mortgage Insurance (BPI), Single Premium Mortgage Insurance, Split Premium Mortgage Insurance and Federal Home Loan Mortgage Protection.

Let's briefly dive into each:

Borrower Paid Mortgage Insurance (BPMI)

By far the most simple and the most common of the types of PMI is Borrower Paid Mortgage Insurance. With BPMI, the cost of your PMI is paid along with your mortgage every month, automatically, until you have 22% equity in your home. Once you've accumulated the required equity, your lender will actually cancel the policy for you.

This is desirable in that it doesn't require any additional money upfront or payments to coordinate, so you can think of it as a "set it and forget it" option...which is good news, because it's often the only option.

Lender Paid Mortgage Insurance (LPMI)

While the name sounds appealing, don't let it fool you. With Lender Paid Mortgage Insurance your lender technically pays the MI for you, but at the cost of a slightly higher interest rate over the life of your loan.

Because LPMI is built into your loan rather than into an additional monthly payment on your tab, it could actually free up some buying funds, allowing you to borrow more for your home.

Single Premium Mortgage Insurance

Single Premium Mortgage Insurance is handled upfront, in one single payment. This is beneficial because it often saves the borrower money, assuming they don't intend to sell the home right away. In the case that the borrower sells or refinances within the first few years, its important to be mindful that SPMI can not be refunded for the remainder of the term left, so they could be leaving money on the table.

Split Premium Mortgage Insurance

Split Premium Mortgage Insurance isn't very common at all, but might be an alternative for buyers with higher, less desirable loan-to-value ratios. Like it's name implies, the premium is split between one upfront payment followed by a continuous monthly premium. This is beneficial when the borrower has cash upfront to put toward the premium, lowering the overall monthly payment enough to qualify.

Federal Home Loan Mortgage Protection (MIP)

While conventional loans require PMI, FHA loans with 10% or less to put down also require its own version of mortgage insurance: MIP. MIP is similar to SPMI in that it often requires a lump sum to be paid upfront, followed by a monthly payment for a minimum of 11 years. 

How much does it cost?

The cost of your private mortgage insurance can vary depending on your down payment and other factors.  The average cost of PMI is typically .50%-1.75% of the initial loan amount, per year. Of course, there are always factors that can inflate premiums beyond average, so understanding your options is the first step in equipping yourself as a smart consumer.   

On a similar note, calculating the cost of PMI is an important step in determining how much home you can afford to buy. [Link to internal PMI calculator with call to action]. Of course, your lender can help you choose the one that's right for you, based on your specific situation and provide solid numbers when the time comes.

Why does the cost of PMI vary?  What factors can influence it?

A few things can impact the amount you can expect to pay for PMI, but it all boils down to risk. Lenders will consider several factors that determine the risk in buying your loan including: down payment amount, credit history, loan to value ratio (LTV), and mortgage term length.

Down Payment Amount

The more you put down upfront, the less likely it is that your lender will require PMI. The general rule of thumb? If you're putting 20% or more towards a home purchase (the typical amount for most loans), then there's little to no chance that your lender will ask for private mortgage insurance coverage.

Credit History

A poor credit score doesn't automatically mean you'll be required to pay PMI any more than a stellar credit history is going to get you out of it. However, it will impact your premium. Except for FHA loans, PMI will be required for buyers with less than 20% down, but those with lower credit scores can expect to pay more per month.

Loan-to-Value Ratio

LTV is the percentage of a home's price you are borrowing compared to its actual value. For instance, if you're buying a house for $100k and only putting down 15% ($15k), then your loan amount would be 85% or .85x$100k = $85k. The larger the LTV, the riskier the investment on the lender's end, because there are more opportunities for the borrower to miss a payment. Naturally, the lower your LTV is, the lower you can expect PMI to cost, or you may eliminate it completely. 

Am I required to have PMI?

Most borrowers who put less than 20% of the purchase price down are required to have PMI. Why? Simply put: the larger the loan-to-value ratio (LTV), the greater the gamble the lender assumes when taking on your loan.

Can I avoid paying for Private Mortgage Insurance?

Yep. Here are some of the ways you can avoid PMI:

Put More Money Down.

When you put 20% or more down at the time of purchase, your mortgage lender will waive any requirement for this type of coverage. 

Piggyback It

An 80/10/10 loan allows you to "piggyback" two loans: one for 80% of the purchase price, and the other for 10% of the purchase price. Borrowers can couple the smaller loan with their own cash upfront to effectively put the required 20% down without actually having to put 20% down, thus waiving the need for PMI.

Pay In Interest

So, this isn't actually "avoiding" PMI, rather trading it. Some lenders will allow borrowers to opt out of paying for PMI in exchange for a higher interest rate on the loan itself. Sound familiar? It should. It's basically Lender Paid Mortgage Insurance.

VA Loan

Did you know VA Loans do not require you to have mortgage insurance? You do now! The VA does, however, charge a funding fee. While similar to PMI in its purpose, the funding fee is either paid upfront or with the borrower's monthly mortgage payment.

The gist of it:

• Private Mortgage Insurance is a type of insurance for home buyers that protects the lender against risk, should the borrower default on the loan. It will impact your monthly mortgage payment and subsequently, sometimes your ability to qualify.
• The cost of PMI can vary for a few reasons, but most often it depends on the borrower's credit score, down payment and loan to value ratio.
• While it's an unfortunately necessary added cost to homeownership, it does have it's benefits like reduced interest rates, and can be cancelled as soon as you've built 20% equity in your home.

Blog Tags: #PrivateMortgageInsurance #MonthlyPayment #Equity