If you're a hopeful homebuyer on a tight budget, private mortgage insurance may be a component of the loan your lender will offer. It's an extra cost that you'd have to shoulder, but you might not qualify for the mortgage you want without it. To help you make the most informed decision about your mortgage, here's an introduction to PMI.
What Is Private Mortgage Insurance?
Unlike most insurance policies you purchase, private mortgage insurance actually protects someone else -- namely, your lender. In the event that you default on your home loan, PMI pays your mortgage lender for the amount of money that it's out because of your financial negligence.
[Read: The Best Mortgage Lenders of 2018.]
Not everyone needs PMI. In fact, homeowners who make a significant down payment can skip it entirely. But, typically, PMI is necessary when your loan-to-value ratio -- the ratio of your outstanding mortgage debt to your home's value -- exceeds 80 percent. For a home purchase, that figure means you're putting down less than 20 percent of the agreed-upon price at closing. And, for a mortgage refinance, it translates to owing more than 80 percent of the assessed home value to your new lender.
In some cases, you may be required to carry PMI, even if you own at least 20 percent of your home. Your lender might insist upon PMI with your conventional mortgage if you're considered a high risk by virtue of a low credit score, a spotty employment history or other criteria.
What Does PMI Cost?
The annual cost for PMI depends on a number of factors, including your credit score and just how close you are to that 20 percent equity ownership. The better your credit score and the larger your down payment, the better rate you'll typically see. Expect to pay anywhere from 0.3 to 1.5 percent of your loan amount for your annual mortgage insurance premium.
You may have the option to make a single PMI payment for the year upfront, but you'll most likely pay in monthly installments that are rolled into your mortgage payment, according to the federal Consumer Financial Protection Bureau.
And, if you're financing a loan through a government program, mortgage insurance could look very different from the PMI you get alongside a conventional loan. Loans backed by the Federal Housing Administration or the Department of Veterans Affairs, for instance, have their own rules, so be sure to learn about your program's mortgage insurance requirements and terms.
[Read: The Best FHA Loans of 2018.]
How Can You Avoid PMI If You're Looking to Finance a Home?
Bill Banfield, executive vice president of capital markets at Quicken Loans, points out that choosing a loan with PMI can sometimes be the best choice for you, even if you have 20 percent saved for your down payment.
"What if you just put 10 percent down, pay the mortgage insurance and then have this extra money in your bank account in case there's an emergency, in case the furnace fails, in case you want to actually decorate your home? There are some really good reasons to think about not being forced to put 20 percent down," he says.
But if you're looking to avoid the costs of PMI entirely, you have a number of options:
-- Save up 20 percent for a down payment. The simplest way to avoid PMI entirely is to make sure your LTV ratio is at or below 80 percent from the start. When you put down at least 20 percent of your home's value, the requirement for PMI almost always disappears. Of course, saving that amount of money can be tricky and time-consuming.
-- Borrow money to hit that 20 percent down payment. Banfield says borrowers sometimes opt for a piggyback loan, also known as an 80-10-10 loan. That structure includes a conventional mortgage covering 80 percent of the purchase price, a second mortgage for 10 percent of the price and a 10 percent down payment provided by the homebuyer.
-- Talk with your lender. If you've got an excellent credit score and present as a great loan applicant, your lender may be willing to forgo the requirement for PMI on your conventional loan. Additionally, Banfield notes that bumping up your credit score can make a big difference in your PMI cost if you do wind up paying it.
-- Find a conventional loan that doesn't require PMI. Your lender may actually offer you some loan options that don't require you to buy PMI if you put down less than 20 percent. Keep in mind that these loans generally include what's called lender-paid mortgage insurance and come with slightly higher interest rates.
-- Look for special lending programs. If finding an affordable loan is proving difficult, look beyond traditional banking institutions. You also may qualify for government programs like an FHA loan or a VA loan. Plus, both the FHA and VA offer refinancing options.
How Can You Eliminate PMI Once You Have It?
Remember that insurance on a conventional mortgage is a temporary need. But you may be able to move the process along -- and save yourself some money -- by being proactive.
Keep track of your LTV. "If certain conditions are met, your loan servicer will automatically cancel your PMI when your loan-to-value ratio reaches 78 percent of the original value of your home," says Allen Seelenbinder, division executive at Bank of America. "However, you can call or write a letter asking for it to be canceled when your LTV hits 80 percent." So check with your lender to see if you meet its eligibility requirements for eliminating your PMI.
Show that you're a model borrower. If you've been lax with your mortgage payments, your lender may not agree to forfeit your PMI coverage, even if you do achieve an LTV ratio of 80 percent. "In most cases," says Seelenbinder, "you'll need to wait at least 24 months after you get your loan and establish a consistent monthly payment history before you can request PMI cancellation."
Accelerate your mortgage. Want to build your home equity quickly? Pay more than the minimum toward your monthly mortgage payments. Specifically, add some extra cash to each of your principal payments. An online calculator can show you exactly how paying more will fast-track your equity growth.
Get the latest data on your home's value. Do you suspect that your home's value has increased significantly? You'll generally see a bump in valuation if the real estate market has changed in your favor or if you've upgraded your property in some way. And, as a result, you'll possess more equity in your home.
In those cases, consider getting an updated home appraisal report to share with your lender. Seelenbinder notes that you may be required to cover the expense of an appraiser yourself. Your lender may have different requirements for substantiating the worth of your property.
Consider refinancing. If rates have dropped significantly since you procured your current mortgage, refinancing could save you major money over the lifetime of your loan, even if it doesn't immediately eliminate your PMI requirement. At the same time, refinancing almost always includes an appraisal. So you could find out along the way that your equity is even larger than you realized.
What Are Your Rights With Mortgage Insurance?
As a borrower, you have certain guarantees when it comes to your PMI. These rights include:
-- The right to real numbers: At closing, your lender is legally bound to inform you exactly how long it will take you to increase your equity enough to cancel your PMI.
-- The right to automatic cancellation of your PMI: When your LTV drops to 78 percent, your mortgage lender is legally bound to drop your PMI and stop charging you for the premiums.
-- The right to request early cancellation of your PMI: As soon as your LTV drops to 80 percent, you may qualify for early elimination of PMI costs.
-- The right to current contact information: Every year, your mortgage company must give you an annual statement and tell you who to contact to request cancellation of your PMI.
When it comes to choosing a home loan, mortgage insurance is an essential part of the equation for many borrowers. And, with the right information on how PMI works, you'll be better prepared to evaluate your options and purchase your home with confidence.
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