Private Mortgage Insurance (PMI) Makes Low Down Payment Loans Possible
It’s an excellent time to be a home buyer with less than 20% down.
Mortgage lenders are making new low- and no-downpayment loans available to today’s home buyers; and purchase loan approval rates are markedly higher as compared to earlier this decade.
Furthermore, current mortgage rates are excellent relative to recent history.
For buyers with less than 20% to put down, though, there’s more than just low rates to think about — there’s private mortgage insurance (PMI), too. PMI required on all conventional loans where the down payment is less than 20% of the home’s purchase price.
PMI is a mandatory insurance policy for conventional loans which insures a lender against loss in the event that the homeowner stops making payments on a mortgage loan.
PMI, because it’s for conventional loans only, is different from the mortgage insurance required on other loans, including FHA mortgage insurance premiums”], which are for FHA loans only; and mortgage insurance premiums required for USDA loans.
It’s important to realize, though, that mortgage insurance — of any kind — is neither “good” nor “bad”. Mortgage insurance helps people to become homeowners who might not otherwise qualify because they don’t have 20% to put down on a home.
Mortgage insurance makes homeownership possible.
When Is Private Mortgage Insurance (PMI) Required?
Private mortgage insurance (PMI) is required when a conventional home loan is used to purchase or refinance a house; and, the borrower makes a down payment of less than twenty percent, or has less than 20 percent equity in the home.
Conventional loans are loans which are backed by Fannie Mae or Freddie Mac and they’re available via all major lenders including Wells Fargo, Bank of America, Quicken, JPMorgan Chase, and others.
PMI is insurance for the lender, paid by the homeowner. It’s the homeowner’s insuring of the lender against its own default. Should the homeowner should ever stop paying on its mortgage, the insurance policy get “cashed”, and the bank gets paid for its losses.
To understand why conventional loans required PMI when the down payment/equity in the home is less than twenty percent, consider what happens during a mortgage default.
When a mortgage default occurs, it’s because the homeowner has stopped making payments on the home and at least 3 consecutive payments have been missed, which creates a loss for the lender.
Often, though, because of state laws which delay the eviction, it can be two years or more before a lender can re-claim a hime. During this time, the home may have incurred damage from fire, flood, or neglect; and may be showing the effects of deferred maintenance.
Deferred maintenance items include roofing issues, structural damage, and the presence of mold, as examples.
By the time the home is eventually sold in foreclosure, then, it’s likely that the lender has incurred a real loss in terms of missed payments; plus, other losses related to the home’s condition.
A lender will typically lose twenty percent of a home’s value during the process of default and foreclosure, which explains the requirement to put 20% down to avoid paying mortgage insurance.
Putting down anything less than 20% puts the lender at risk.
Private mortgage insurance covers lenders against loss. The less you put down for a down payment on a conventional loan, then, the larger your mortgage insurance policy will be.
The lone exception is the HomeReady™ home loan, which allows for just 3% down. HomeReady™ offers discounted private mortgage insurance rates to match its discounted mortgage rates.
The program has been available since late-2015.
The Three Types Of PMI Coverage
As a homeowner, you have options for how you pay the private mortgage insurance required.
One option is known as “single premium”, in which you make a lump-sum payment at the time of closing which covers your PMI policy for as long as your mortgage is active.
A second option is “lender-paid mortgage insurance” (LPMI) which requires no monthly payment whatsoever, but for which your mortgage rate will be raised to offset the lender’s additional risk.
The third option is “monthly premiums”, which is the most common method by which homeowners pay PMI. The annual cost of insurance is split into 12 parts, and collected with each month’s mortgage payment.
In the PITI of a mortgage payment, mortgage insurance is the second “I”.
Each of the option has its merits.
Homeowners who plan to keep their current loan and expect home values to moderate or remain flat may prefer the single premium option, which may limit long-term costs.
By contrast, homeowners who intend to move or refinance within the first few years of the loan may prefer lender-paid MI, which raises the mortgage rate by a small amount, but which requires no separate payment.
For everyone, monthly premiums are likely the best fit. Payments are regular, then cancel out as the loan pays down over time and as the home increases in value.
How To Cancel Your PMI Coverage
Private mortgage insurance gets a bad rap.
Buyers have called it “stupid”, “a waste of money”, and worse. “I shouldn’t buy a home if I can’t afford 20% down”, they’ll sometime say.
But private mortgage insurance serves a purpose.
PMI lets a buyer purchase a home with less than 20% down. The cash not used for downpayment can be used to finance home improvements; to keep an emergency fund invested with a bank; or, for any other purpose.
Access to PMI also lowers barriers-to-entry for first-time home buyers.
Currently, the median U.S. sale price is near $250,000, Without access to PMI, a home buyer would need to make a $50,000 down payment in order to purchase a home via a conventional loan.
With access to PMI, the home buyer’s downpayment can shrink to $7,500.
PMI adds to your monthly payment, but that’s okay. Many home buyers can afford the monthly mortgage insurance premiums. It’s coming up with a down payment that keeps them from buying a home.
PMI is the price you pay for the ability to put down less than 20%.
Even better, private mortgage insurance is impermanent.
As a homeowner, once you can show that your home’s equity position has reached twenty percent, you reserve the right to ask your lender to have your PMI removed. In many cases, your PMI payments can be canceled immediately.
There are two ways by which your home equity can reach the required levels for PMI cancelation.
- Your loan balance is paid down to 78% of the home’s original purchase price. This happens with regular monthly payments to your lender, eventually.
- Request a home appraisal from your lender which shows 20% home equity
Lenders are required by law to cancel private mortgage insurance once either of the above options can be proved. However, consumers can be pro-active about canceling PMI, too.
Home values are rising nationwide and homeowners have seen their home equity levels rise, in turn. Meanwhile, as home values have climbed, mortgage rates have been dropping.
This creates an excellent opportunity to refinance.
There are an estimated 6.5 million U.S homeowners currently eligible to refinance their home loans, and many of these homeowners currently pay private mortgage insurance.
A new loan, which would require a new appraisal, may show the requisite 20% home equity required to ditch the PMI. In this way, homeowners can refinance their PMI away.
What Are Today’s Mortgage Rates?
Private mortgage insurance is neither “good” nor “bad” — it’s merely an option which makes low down payments possible. And, for today’s home buyers, that option is attractive.