Mortgage insurance can make it possible to purchase a home with less than a 20% down payment. But many homebuyers are understandably confused about how it works, how much it costs and whether there are different ways to structure it.
For many conventional mortgages with a loan-to-value ratio above 80%, private mortgage insurance may be required. PMI protects the lender against certain losses if the borrower defaults on the mortgage. It does not provide insurance protection to the homeowner.
The important thing for borrowers to understand is that PMI is not necessarily a one-size-fits-all expense. Depending on the loan program and available options, there may be several ways to structure the cost.
What Determines the Cost of PMI?
The cost can vary considerably from one borrower to another. Factors can include your credit profile, down payment or loan-to-value ratio, loan characteristics and the type of coverage selected.
This is why two borrowers purchasing similarly priced homes may have very different PMI costs.
Monthly PMI
Monthly PMI is one of the most common payment structures. The premium is included with the monthly mortgage payment rather than requiring a large insurance payment at closing.
This structure can be attractive because it keeps the upfront cash requirement lower. Depending on the loan and applicable requirements, borrower-paid PMI may also eventually be eligible for cancellation or termination.
For many qualifying conventional mortgages, a borrower can request cancellation when the principal balance is scheduled to reach 80% of the home’s original value, provided applicable requirements are satisfied. In general, automatic termination occurs when the scheduled principal balance reaches 78% of the original value and the borrower is current on the mortgage. Additional rules and exceptions can apply.
Lender-Paid PMI
With lender-paid PMI, the lender pays the premium rather than having the borrower make a separate monthly PMI payment.
The cost is generally incorporated into the economics of the loan, often through the interest rate or other pricing. As a result, the borrower may have a higher mortgage rate but no separate monthly PMI charge.
This can sometimes produce a lower total monthly payment than a loan with borrower-paid PMI. However, because the cost is incorporated differently, it is important to compare the long-term economics rather than simply looking at whether a separate PMI charge appears in the payment.
Single-Premium PMI
Single-premium PMI allows the premium to be paid as a lump sum rather than as an ongoing monthly charge.
Depending on the transaction and loan program, the premium may be paid at closing or, when permitted, some or all of the premium may be financed into the mortgage.
The advantage is that there may be no ongoing monthly PMI payment. The tradeoff is the larger upfront cost or potentially larger loan balance if the premium is financed.
How long you expect to own the home or keep the mortgage can be particularly important when evaluating this option.
Split-Premium PMI
Split-premium PMI combines an upfront payment with a reduced ongoing monthly premium.
This creates a middle ground between paying the entire premium upfront and paying the full cost monthly. Depending on the pricing available, it can be useful when a borrower wants to reduce the monthly payment without paying the entire cost at closing.
Financing the Premium
Some eligible conventional transactions may allow all or part of certain borrower-paid premiums to be financed into the loan amount.
This can reduce the amount of cash required at closing, but it also increases the mortgage balance. This structure is subject to loan-program, property, loan-to-value and other eligibility requirements, so it is not available for every transaction.
Which PMI Option Is Best?
There is no single structure that is best for every borrower.
When comparing options, I look at several factors, including:
- Monthly mortgage payment
- Cash required at closing
- Credit profile
- Down payment and loan-to-value ratio
- Interest rate and loan pricing
- How long the borrower expects to own the home
- How long the borrower expects to keep the mortgage
- Potential PMI cancellation or termination
Sometimes the lowest monthly premium produces the best overall structure. In another scenario, lender-paid, single-premium or split-premium PMI may make more sense.
The best way to know is to compare the actual numbers side by side.
Can PMI Be Removed?
In many cases, yes. Borrower-paid private mortgage insurance on certain conventional mortgages can eventually be cancelled or automatically terminated when applicable requirements are met.
Federal law generally provides borrowers with the right to request PMI cancellation when the mortgage is scheduled to reach 80% of the property’s original value, subject to requirements such as payment history, being current on the loan and other conditions.
For many covered mortgages, PMI generally terminates automatically when the scheduled principal balance reaches 78% of the property’s original value, provided the borrower is current. Fannie Mae, Freddie Mac, servicers and insurers may also have additional requirements or options for cancellation in certain circumstances.
Government-insured mortgages, lender-paid coverage and some other loan types follow different rules, so borrowers should not assume that conventional PMI cancellation rules apply to every mortgage.
Is Putting Less Than 20% Down a Bad Idea?
Not necessarily. Some buyers automatically assume they should wait until they have a 20% down payment simply to avoid PMI. That is not always the best financial decision.
A lower down payment can allow a buyer to purchase sooner, retain more money in savings or keep funds available for repairs, improvements and emergencies. The right decision depends on the financing options available and the borrower’s overall financial situation.
Rather than looking at PMI by itself, I prefer to compare the complete financing options and determine which structure makes the most sense for the borrower.
Questions About Mortgage Insurance?
I have worked with homebuyers throughout Maryland, Washington DC and Virginia for more than 20 years. If you are comparing down payment options or want to understand how different PMI structures affect your payment and closing costs, contact me. I can compare the available options with you side by side.
For additional information about private mortgage insurance cancellation and termination rights, you can also review the Consumer Financial Protection Bureau’s PMI guidance.
Mortgage insurance availability, pricing, cancellation requirements and loan-program guidelines vary and are subject to change. This information is for general educational purposes and is not a commitment to lend. Borrowers should consult their loan servicer regarding cancellation or termination requirements for an existing mortgage.
