When lenders approve you for a loan, they take a risk. They risk you not paying the mortgage back, which means the bank takes a loss. While foreclosure sales earn banks some money back, they still suffer financially for each foreclosure.
PMI or Private Mortgage Insurance helps banks offset the risk. Private insurance companies issue the insurance that protects lenders should you default. Conventional loan borrowers who put less than 20 percent down on a home pay PMI.
Who Does PMI Protect?
Ideally, PMI protects lenders. If you don’t make your payments, the insurance company reimburses the lender some money they lost. But, that doesn’t mean PMI doesn’t protect you too. Here’s how.
If you put less than 20 percent down on a conventional loan, lenders are at risk. With a 20 percent down payment, you’re more likely to make your payments on time so you don’t lose your own investment. Without that 20 percent down, lenders take a big risk. PMI offsets that risk, though, enabling you to secure a mortgage and buy your dream home.
How Much Does PMI Cost?
PMI costs an average of 0.5 percent to 1 percent of the loan amount annually. A $200,000 mortgage may cost between $1,000 to $2,000 per year or $83 to $167 per month. This is in addition to your mortgage payment, including the principal, interest, real estate taxes, and homeowner’s insurance.
How do you Pay PMI?
How you pay PMI differs by lender. The average borrower pays PMI monthly, as we discussed above. You also have the following options:
- Lump sum payment – You pay the entire premium upfront at the closing. You don’t make any further PMI payments throughout the life of the loan. But if you sell the home and/or pay the loan off early, you don’t receive a refund.
- Upfront and annual PMI – Some borrowers pay a portion of the PMI up front and the rest in their mortgage payments. They do this to reduce the monthly PMI payments.
How to Cancel PMI
PMI doesn’t last forever, unlike the mortgage insurance charged on FHA and USDA loans. Once you owe less than 80 percent of the home’s value, you may cancel your PMI. If you pay your loan down faster than scheduled or your home appreciates faster, you can request cancelation in writing.
Lenders aren’t required to cancel your insurance, though. They determine if you’ve made your payments on time and are a good risk. If you can’t cancel your PMI early, by law, lenders must automatically cancel it once you owe less than 78 percent of the home’s value.
PMI helps you get conventional financing. If you have just 5 percent to put down, you can still secure this competitive financing option. Conventional loans have low interest rates and low closing costs, so it’s a beneficial loan program.
If you want to avoid PMI, you’ll need a larger down payment (at least 20 percent) or the combination of a down payment and a second mortgage, called a piggyback loan, to make up the difference.
