In the wake of the pandemic, there were record-low mortgage rates across the nation for nearly two years. Although rates have risen in 2022, this year is still a great time for aspiring homeowners. But as you’re researching different financing options, you might notice a cryptic term that keeps popping up: private mortgage insurance.
What do you need to know about taking out private mortgage insurance? Who needs private mortgage insurance? And how much does private mortgage insurance cost?
We’ll answer these important questions and more, so keep reading below.
Private Mortgage Insurance: What Is It?
Private mortgage insurance (PMI) is generally required on all conventional home loans when the buyer’s downpayment is less than 20% of the purchase price.
It’s not designed to protect the buyer. Instead, it protects the lender in case the homeowner defaults on the loan. If the homeowner stops making payments, the lender “cashes in” the PMI policy and pays the bank for its losses.
These days, most buyers aren’t able to save the traditional 20% downpayment for a new home. In fact, 80% of buyers put down less than 20% when buying a home. This means that four out of five buyers need private mortgage insurance for their new homes.
Why Do Lenders Require PMI?
Imagine a homeowner who, for one reason or another, stops paying his mortgage.
After three months, the loan defaults, and the house goes into foreclosure. It might seem like the lender can immediately reclaim the home, but the reality is very different.
In some states, it can take two years (or longer) to evict the resident and take back possession of the home. In the meantime, the house may fall into a state of disrepair and neglect. By the time the eviction occurs, the house may have structural damage, mold, or other problems resulting from deferred maintenance.
Not only has the lender lost out on mortgage payments, but now there are also losses based on the home’s poor condition. In fact, a lender loses an average of 20% of the home’s value during the default and foreclosure process.
Is it just a coincidence, then, that lenders require PMI when buyers put down anything less than 20%?
Is Private Mortgage Insurance Necessary?
If we’re talking about conventional loans made by major lenders, the answer (most likely) is yes. These include any loans backed by Fannie Mae or Freddie Mac and offered through institutes like Quicken, Bank of America, Wells Fargo, JP Morgan Chase, etc.
Interestingly, VA loans do not require private mortgage insurance, although there is a “funding fee” to be aware of. Federally funded FHA or USDA loans also operate a little differently when it comes to PMI.
In general, your PMI becomes another monthly payment in addition to your mortgage payment, homeowners insurance, and property taxes. (Although you may be able to structure your PMI payments differently, which we’ll get to in a moment).
The good news is that you won’t have to pay for private mortgage insurance forever. Once you’ve reached that magical 20% equity mark (either through payments or your home’s value increasing), your lender is legally obligated to remove the PMI from your mortgage.
How Much Does Private Mortgage Insurance Cost?
Like other types of loans and insurance, the answer depends on your credit score and your loan-to-value ratio. The higher your credit score and lower your LTV, the lower your PMI payments will be.
Generally speaking, PMI premium rates fluctuate between 0.5% and 1.8%. Assuming you bought a $250,000 home and put 3.5% down, your PMI could cost between $117 and $374 a month.
If you’re worried about doing the math on your own, don’t worry. A good mortgage loan calculator will factor the cost of PMI into your payment plan.
At first glance, this private mortgage insurance requirement might seem like a waste of money. But think about the potential benefits of being able to buy a home without wasting more time and money on rent. It also frees more cash for you to spend or invest, rather than tying up all your savings into home equity.
Understanding PMI Options
Now that you know the ins and outs of private mortgage insurance, let’s take a brief look at the different types of PMI.
Borrower-Paid Mortgage Insurance (BPMI)
This type of PMI is the most common. You pay it in monthly installments along with your regular mortgage payment. Once you’ve reached 22% equity in your home, the lender must cancel the BPMI.
Single-Premium Mortgage Insurance (SPMI)
Also called single-payment mortgage insurance, this option allows buyers to pay their annual PMI in one upfront lump sum. This results in lower monthly payments and the ability to borrow more to buy the house. However, if you sell or refinance the house within a few years, the PMI is non-refundable.
Split-Premium Mortgage Insurance
This hybrid arrangement lets you make a partial payment upfront and roll the remainder into your monthly mortgage payments. This option is ideal for buyers with a high debt-to-income ratio.
Federal Home Loan Mortgage Protection (MIP)
This option is only available on loans that are underwritten by the FHA. They’re required on all loans with down payments of 10% or less. It’s set up as a hybrid, with both upfront and monthly payments.
Talk to the Portland Mortgage Experts
If you’re planning to buy a house with less than a 20% downpayment, your lender may have a private mortgage insurance requirement.
As we’ve discussed, this isn’t necessarily a bad thing. It gives you the opportunity to join the ranks of homeownership without wasting more time saving for the downpayment. Like your home, it’s an investment in your financial future.
Are you hoping to buy a home in the Pacific Northwest? Would you like more information about mortgages and home financing in Portland or other parts of Oregon?
The Lindley Team is here to help. Give us a call at 503.517.8641 or use our online contact form to get in touch. We look forward to hearing from you!