If you are not putting 20% down on your home purchase, Private Mortgage Insurance (PMI) will be a factor to consider when calculating your monthly housing budget.
PMI is insurance that protects the lender against losses in the rare case a mortgage borrower is not able to repay the loan and the lender is not able to recover its costs after foreclosure and sale of the mortgaged property.
There are a few ways you can choose to structure your PMI:
Borrower-Paid Mortgage Insurance (BPMI)
BPMI is paid monthly to your loan servicer along with your principal and interest payment. The monthly premium varies for every borrower and is based on credit score, loan amount, and down payment amount.
If you choose to structure your PMI this way, there are generally two ways to drop the premium from your home loan.
A. Requesting PMI Cancellation
You have the right to request that your loan servicer cancel the PMI when you have reached the date when the principal balance of your mortgage is scheduled to fall to 80 percent of the original value of your home. This date is provided on a PMI disclosure form when you obtain your mortgage.
You can ask to cancel PMI earlier if you have made additional payments that reduce the principal balance of your mortgage to 80 percent of the original value. Important criteria for canceling PMI on your loan includes good payment history, being current on your payments, and evidence that the value of your property has not declined. When requesting cancellation of PMI, the request must be in writing and the servicer may require an appraisal at the borrower’s expense.
B. Automatic PMI Termination
Even if you don’t ask your servicer to cancel PMI, your servicer must automatically terminate PMI on the date when your principal balance is scheduled to to reach 78 percent of the original value of your home. For your PMI to be canceled on that date, you need to be current on your payments on the anticipated termination date; otherwise, PMI will not be terminated until after your payments are brought up to date.
Lender-Paid Mortgage Insurance (LPMI)
This PMI structure is built into the cost of your loan resulting in a higher interest rate. The amount of the interest rate increase will vary for every borrower based on a number of factors such as credit score, loan amount, and down payment amount.
If you choose this option you will not have a monthly PMI payment, and the increase in the amount of interest you will pay each month may be less than a monthly PMI payment would be for the same loan.
LPMI is built into the cost of your loan and cannot be removed for the life of the loan, regardless of the equity stake that you gain in your home. The only way to remove LPMI is to refinance or pay off your loan.
Single-Premium Mortgage Insurance (SPMI)
SPMI is a one-time, lump sum payment. The cost of the premium payment varies for every borrower and is based on credit score, loan amount, and down payment amount.
There are two ways to pay for SPMI:
A. Financed single premium
The PMI premium is added to your loan amount and paid for over the full term of the loan as part of your mortgage payment.
B. Non-financed single premium
The PMI premium is paid at closing with the rest of the standard closing costs.
How To Remove PMI From Your Mortgage
There are three options for eliminating the PMI obligation associated with your mortgage if you have a conventional loan (PMI on FHA loans is permanent).
A. Refinance
If your property appreciates to the point where your lender can garner a new appraisal to support a value high enough to reduce your loan-to-value ratio to 80% or less, you can refinance into a new loan with no PMI. This assumes of course that rates remain favorable. Keep in mind that most appraisers will correlate to the purchase price for the first 6 months, making it wise to wait at least this long to start the refinance process.
B. Pay your loan down to an amount equal to 80% of the original purchase price
You can also eliminate PMI by paying your loan down if: (1) you notify your servicer with your request; (2) you have a good payment history; and (3) you are willing to prove to the servicer that your property has not depreciated with an appraisal.
C. Prove your home has appreciated to the point where the loan-to-value ratio is at 75% or less
If your loan is owned/backed by Fannie Mae or Freddie Mac (a.k.a. a conventional loan), you can eliminate PMI if: (1) you notify your servicer with your request; (2) your loan has seasoned for two years with a good payment history; and (3) you provide a current appraisal with a high enough value to support a 75% LTV.
Is PMI Right For You?
It’s important to keep in mind that mortgage insurance is not just for people who can’t afford a 20% down payment. It’s also for those who don’t want to put down 20% so they have more cash on hand for repairs, remodeling, furnishings, and emergencies.
Your specific PMI rate, how long you’ll have to pay, and whether BPMI, LPMI, or SPMI is better for you depends on your individual loan and your unique financial situation. When you’re shopping for a home, ask your lender how they handle mortgage insurance and how much you could expect to pay in PMI – or another type of mortgage insurance.
Our team at NEO is here to help you figure out the right mortgage insurance strategy for you so you can maximize your wealth and take the next step on your journey to financial freedom. Fill out the form below to request a free consultation with one of our mortgage advisors.