Today Norah Tanner, part of Carter Campbell’s team at Houzd Mortgage, is explaining private mortgage insurance and why it may or may not be part of your home loan.

When it comes to buying a home, one term that often comes up in conversations with lenders and real estate agents is Private Mortgage Insurance, commonly known as PMI. For many potential homeowners, especially first-time buyers, understanding PMI is crucial as it can significantly impact the affordability and terms of your mortgage. In this article, we'll explore what PMI is, why it exists, and how it affects both buyers and lenders.

Understanding PMI

Private Mortgage Insurance (PMI) is a type of insurance that lenders require from homebuyers who make a down payment of less than 20% of the home's purchase price. The primary purpose of PMI is to protect the lender in case the borrower defaults on the loan. Because buyers with smaller down payments are considered higher risk, PMI provides a layer of financial security for the lender.

Why PMI Exists

PMI was created to make homeownership more accessible to individuals who might not have substantial savings for a large down payment. By offering protection to lenders, PMI allows them to approve loans for buyers with lower down payments, thus enabling more people to purchase homes without waiting years to save for a 20% down payment.

How PMI Works

PMI is typically required for conventional loans when the down payment is less than 20%. The insurance can be structured in several ways:

Monthly Premiums: This is the most common form, where the PMI premium is added to your monthly mortgage payment.

Upfront Premium: Some lenders offer the option to pay the PMI premium as a one-time upfront cost at closing.

Split Premium: A combination of both upfront and monthly premiums.

Lender-Paid PMI: In this case, the lender pays the PMI premium, but the cost is usually passed on to the borrower in the form of a higher interest rate.

How Much Does PMI Cost?

The cost of PMI varies based on several factors, including the size of the down payment, the loan amount, the loan term, and the borrower’s credit score. On average, PMI can range from 0.3% to 1.5% of the original loan amount per year. For example, on a $200,000 mortgage, PMI could cost between $600 and $3,000 annually, or $50 to $250 per month.

How to Avoid or Eliminate PMI

20% Down Payment: The simplest way to avoid PMI is to make a down payment of at least 20% of the home's purchase price.

Piggyback Loans: Some buyers opt for a piggyback loan, where they take out a second loan to cover part of the down payment, thus avoiding PMI.

Refinance: Once you’ve built up 20% equity in your home, you can refinance your mortgage to eliminate PMI.

Request Cancellation: Once your loan-to-value ratio (LTV) reaches 80% through payments or home value appreciation, you can request your lender to cancel PMI. By law, lenders must automatically terminate PMI when your LTV reaches 78%, provided you are current on your payments.

The Pros and Cons of PMI

Pros:

Accessibility: PMI allows buyers to purchase a home sooner without needing a large down payment.

Flexibility: Different payment options are available, including monthly, upfront, or a combination of both.

Cons:

 Additional Cost: PMI increases your monthly mortgage payments, adding to the overall cost of homeownership.

No Direct Benefit: PMI protects the lender, not the borrower. You pay the premiums, but only the lender benefits from the coverage.

Private Mortgage Insurance is an essential aspect of the mortgage landscape, designed to bridge the gap for those who cannot afford a 20% down payment. While it does add to the cost of buying a home, PMI makes homeownership more accessible to many people. Understanding how PMI works and how to manage it can help you make informed decisions and potentially save money in the long run. As with any financial product, it's crucial to evaluate your options and consult with your lender to determine the best approach for your situation.