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Private Mortgage Insurance (PMI) is a type of insurance that borrowers may be required to purchase if they take out a conventional loan with a down payment of less than 20 percent of the purchase price. PMI protects the lender, not the borrower, in the event that the borrower stops making payments on the loan. It is important to note that PMI does not protect the borrower from foreclosure or loss of their home if they fall behind on mortgage payments.
PMI is typically arranged by the lender and provided by private insurance companies. It is designed to insure the lender against financial loss caused by borrowers failing to make loan payments. The requirement to buy PMI usually applies not only to the initial purchase of a home but also to refinancing a conventional loan when the borrower’s equity is less than 20 percent of the home’s value.
How Does Private Mortgage Insurance Work?
Private mortgage insurance is usually paid for by the borrower and can be included in the monthly mortgage payment. The cost of PMI can vary but is typically between 0.5% and 1% of the loan value on an annual basis. The specific premiums for PMI will be detailed by the lender in the initial loan estimate and the final closing disclosure form.
The purpose of PMI is to allow borrowers to qualify for a loan that they might not otherwise be able to obtain due to a lower down payment. It can help borrowers with limited funds to enter the housing market sooner. However, it is important to consider that PMI increases the overall cost of the loan.
Examples of Private Mortgage Insurance
Let’s consider a couple of examples to illustrate how private mortgage insurance works:
Example 1:
John is purchasing a home for $250,000 and is making a down payment of 10 percent, which amounts to $25,000. Since his down payment is less than 20 percent of the purchase price, his lender requires him to obtain PMI. The cost of PMI is 0.8% of the loan amount annually. In this case, John’s loan amount is $225,000 ($250,000 – $25,000), so his annual PMI premium would be $1,800 ($225,000 * 0.008).
Example 2:
Sarah is refinancing her home, which is currently valued at $300,000. She has paid down her mortgage principal to $240,000, which is 80 percent of the home’s value. Since her equity is now 20 percent or more, she is eligible to have the PMI removed from her loan. Sarah contacts her lender, provides the necessary documentation, and the lender removes the PMI from her monthly mortgage payment.
Can PMI be Removed?
The ability to remove PMI from a loan depends on several factors, including the loan-to-value (LTV) ratio and the specific policies of the lender. The Homeowners Protection Act of 1998 requires lenders to automatically remove PMI when the borrower reaches a 78 percent LTV ratio. However, borrowers can request PMI removal once they reach a 80 percent LTV ratio. It is important to note that these requirements apply to mortgages for single-family principal residences that closed on or after July 29, 1999.
In addition to the LTV ratio, other conditions may need to be met for PMI removal, such as having no recent mortgage payment delinquencies, no decline in property value, and no subordinate liens. It is recommended to contact the lender or servicer for specific information about removing PMI from a loan.
Conclusion
Private Mortgage Insurance (PMI) is a type of insurance that protects the lender if the borrower stops making payments on a conventional loan with a down payment of less than 20 percent. PMI allows borrowers to qualify for loans with lower down payments, but it increases the overall cost of the loan. The ability to remove PMI depends on factors such as the loan-to-value ratio and the lender’s policies. It is advisable to contact the lender or servicer for detailed information about PMI removal.
