What is Private Mortgage Insurance (PMI) & Why It’s Required
Private mortgage insurance (PMI) is a type of insurance that is required for some mortgages. It is designed to protect lenders in the event that a borrower defaults on their loan. PMI is typically required for borrowers who are putting down less than 20% of the home’s purchase price as a down payment. The purpose of PMI is to reduce the lender’s risk and make it easier for borrowers to obtain a mortgage.
PMI can be a significant cost for borrowers, as it is typically added to their monthly mortgage payment. The cost of PMI varies depending on the lender, the size of the down payment, and other factors. PMI can range from 0.3% to 1.5% of the original loan amount each year, which can add up to thousands of dollars over the life of the loan.
Why is PMI required for some mortgages?
There are several reasons why PMI is required for some mortgages. First, it helps lenders reduce their risk. When borrowers put down less than 20% of the home’s purchase price as a down payment, they are considered to be at a higher risk for default. This is because they have less equity in the home and are more likely to walk away from the loan if they encounter financial difficulties. PMI helps protect the lender in the event that this happens.
Another reason why PMI is required for some mortgages is that it makes it easier for borrowers to obtain a mortgage. When borrowers have less than 20% to put down as a down payment, lenders may be hesitant to approve their loan application. PMI can give lenders the reassurance they need to approve the loan, as it provides a level of protection against default.
PMI can be a significant cost for borrowers, and it’s important to understand how it works and how to calculate its costs. The cost of PMI is typically based on the size of the down payment, the loan amount, and the borrower’s credit score. Borrowers can use online calculators to estimate the cost of PMI based on these factors.
How is PMI calculated?
To calculate the cost of PMI, borrowers should first determine the size of their down payment. For example, if a borrower is putting down 10% on a $200,000 home, their down payment would be $20,000. The loan amount would be $180,000. The cost of PMI would be based on this loan amount.
Borrowers can expect to pay anywhere from 0.3% to 1.5% of the loan amount each year for PMI. To calculate the annual cost of PMI, borrowers can multiply the loan amount by the PMI rate. For example, if the PMI rate is 0.5%, the annual cost of PMI for a $180,000 loan would be $900.
How to get rid of PMI.
It’s important for borrowers to understand that PMI is not a permanent cost. Once they have built up enough equity in the home, they can request that PMI be removed from their mortgage. This typically requires the borrower to have paid off at least 20% of the home’s purchase price. Borrowers can also request that PMI be removed if the value of their home has increased significantly.
Alternatives to PMI.
There are several alternatives to PMI that borrowers can consider. One option is a piggyback mortgage, which involves taking out a second mortgage to cover the down payment. Another option is lender-paid mortgage insurance, where the lender pays the cost of the mortgage insurance in exchange for a higher interest rate. These options can be more expensive than PMI, but they can also help borrowers avoid the monthly cost of PMI.
In summary, private mortgage insurance (PMI) is a type of insurance that is required for some mortgages. It is designed to protect lenders in the event that a borrower defaults on their loan.
How to choose the best PMI option for your needs.
It is important to note that not all mortgages require PMI. Some lenders may offer alternative options, such as a piggyback mortgage or lender-paid mortgage insurance. A piggyback mortgage involves taking out a second mortgage to cover the down payment and avoid PMI. Lender-paid mortgage insurance involves the lender paying the cost of the PMI upfront in exchange for a slightly higher interest rate on the mortgage.
In summary, PMI is a requirement for some borrowers who are unable to put down a large down payment when purchasing a home. It allows lenders to extend mortgages to borrowers who may not have been able to purchase a home otherwise, promoting homeownership. While it can be costly, it is temporary and can be cancelled once the borrower’s equity in the home reaches 20%. Borrowers should consider alternative options, such as a piggyback mortgage or lender-paid mortgage insurance, if available, to avoid the cost of PMI.