Private mortgage insurance (PMI)
Private mortgage insurance (PMI) is a form of insurance designed to protect lenders in the event that a borrower defaults on their mortgage. It is typically required when a borrower makes a down payment of less than 20% of the home's purchase price, allowing individuals to secure a mortgage with a smaller initial investment, often as low as 3%. PMI is an added cost that is included in the monthly mortgage payment, and borrowers usually pay it until they reach approximately 20% equity in their home.
Different types of home loans may or may not require PMI. Conventional fixed-rate and adjustable-rate mortgages often necessitate PMI for lower down payments, while government-backed loans like FHA, VA, and USDA loans have their own insurance requirements, with some not requiring PMI at all. The cost of PMI can vary, generally ranging from 0.25% to 2% of the total loan amount annually, influenced by the down payment size, loan duration, and credit score of the borrower.
There are various types of PMI, including single premium, lender-paid, and borrower-paid options, each with distinct payment structures and cancellation rules. Borrowers can often cancel PMI once their mortgage balance falls below 80% of their home's value, but they must notify their lender to ensure timely cancellation. Understanding PMI can be crucial for potential homebuyers aiming to navigate the complexities of financing a home purchase.
On this Page
Subject Terms
Private mortgage insurance (PMI)
Private mortgage insurance (PMI) is a type of insurance that protects the lender of a mortgage (home loan) if a borrower defaults (does not pay the loan). It is an additional fee added to the expenses associated with a mortgage payment. Not all types of home loans carry PMI. It is only required on mortgages in which the borrower's down payment is less than the required 20 percent of the home's purchase price. Paying PMI allows people to purchase a house with a smaller down payment (at least 3 percent). Buyers usually only have to pay PMI until they have accumulated about 20 percent of their home's equity, or value.
Types of Home Loans
Several types of home loans exist, but not all of them require PMI. A fixed-rate conventional mortgage is a loan that has an interest rate that does not fluctuate. The loan payment is always the same every month and never changes for the life of the loan. Conventional loans typically are paid back over thirty years; however, some have terms for as little as ten years. Most conventional mortgages require a down payment of 20 percent of the price of the home. Borrowers who put down less usually have to pay PMI. Some conventional loan programs may require less down if a person has a high credit score. A credit score is a three-digit number (between 300 and 850) that predicts if a person will default on their debt obligations. The higher the credit score—typically above 700—the better the chance a person will pay their debts.
An adjustable-rate mortgage (ARM) is a conventional loan with a changing interest rate. The amount of the loan payments fluctuates from year to year, depending on the interest rate. Some ARMs are hybrid loans, which means they begin with a fixed interest rate but then switch to an adjustable interest rate and usually stay adjustable for the remaining life of the loan. As with fixed-rate conventional loans, borrowers will be required to pay PMI on an ARM if they do not have a 20 percent down payment. The primary difference between the two types of conventional loans is that a fixed-rate payment never changes, while an adjustable-rate payment changes from year to year.
The US government offers three types of government-backed loans: Federal Housing Administration (FHA), Veterans Affairs (VA), and United States Department of Agriculture (USDA). The US Department of Housing and Urban Development (HUD) oversees FHA loans. Popular with first-time buyers, this type of loan is available to people who do not qualify for conventional home loans, do not have enough money for a down payment, or do not have good credit. An FHA loan only requires 3.5 percent of a home's cost as a down payment. The government insures FHA loans, so lenders are compensated if a seller defaults. FHA loans are available to people with credit scores as low as 500. People with credit scores under 500 may qualify for an FHA loan as long as they have a down payment of at least 10 percent. While FHA loans do not require PMI, they do require borrowers to pay for mortgage insurance. Unlike PMI, mortgage insurance premium (MIP) on FHA loans must be paid for the entire length of the loan and often have an upfront premium to be paid at the time of closing.
The US Department of Veterans Affairs offers a VA loan for active military personnel, veterans, and their families. Also backed by the government, VA loans do not require any down payments and offer lenders 100 percent financing as long as they meet specific military service requirements. VA loans are not dependent on credit scores and do not require PMI or other mortgage insurance.
The Rural Housing Service (RHS) oversees USDA loans. These are available to people with low and middle-income ranges (no higher than 115 percent of the adjusted area median income) in areas deemed "rural" by the USDA. USDA loans do not require a down payment or PMI; however, they do have an upfront fee of about 1 percent of the total loan and monthly mortgage insurance fees called guarantee fees, which is typically 0.35 percent of the outstanding loan total.
How PMI Works
PMI is applied to both fixed- and adjustable-rate conventional loans. The cost of PMI typically ranges from 0.5 to 2 percent of the total loan balance per year, but can range from 0.25 to 6 percent. The rate is dependent on how much a person puts down on the loan, the length of the loan, and a borrower's credit score. If a person is deemed a high risk of defaulting (because of a low credit score or other factors), the borrower will pay a higher PMI.
Three main types of PMI exist: single premium, lender-paid, and borrower-paid. With single premium PMI, home buyers can pay the PMI in one lump sum at the time of closing or have it rolled into the total mortgage. Lender-paid PMI is paid as part of the mortgage interest rate for the entire length of the loan. While this type reduces the monthly payment, borrowers end up paying more interest over the life of the loan. Lender-paid PMI cannot be canceled after a home reaches 20 percent equity.
Borrower-paid PMI is typically cancelled when borrowers satisfy 20 percent of their mortgage's principal and are not in default of the mortgage. Lenders should provide borrowers with a schedule of how long it will take to pay 20 percent of their mortgage's principal. However, it is the responsibility of homeowners to keep track, and they should notify the lender when their home's equity reaches 20 percent and ask for PMI cancellation. Borrowers who have made additional principal payments typically qualify for PMI cancellation sooner. If the homeowners do not notify the lender when they reach 20 percent, the lender is required to cancel the PMI when the borrowers' home equity reaches 22 percent.
Another form of PMI is a hybrid of borrower-paid and single-premium mortgage insurance called split-premium, which requires a premium of 0.5 to 1.25 percent of the mortgage total to be paid upfront, and the remaining mortgage insurance costs are taken from monthly payments. This allows individuals who do not qualify for a borrower-paid PMI based on their debt-to-income ratio or those who only qualify for a small loan to borrow more.
Bibliography
Cornett, Brandon. "Types of Mortgage Loans: An A-to-Z Glossary for Home Buyers." Home Buying Institute, 2024, www.homebuyinginstitute.com/mortgagetypes.php. Accessed 27 Dec. 2024.
Dedmon, Julie. "Understanding Mortgage Insurance." Flagstaff Business News, 28 Nov. 2016, www.flagstaffbusinessnews.com/understanding-mortgage-insurance. Accessed 27 Dec. 2024.
Dehan, Andrew. "Private Mortgage Insurance (PMI): What It Is and How It Works." Bank Rate, 11 Nov. 2024, www.bankrate.com/mortgages/basics-of-private-mortgage-insurance-pmi. Accessed 27 Dec. 2024.
Fontinelle, Amy. "5 Types of Private Mortgage Insurance (PMI)" Investopedia, 16 June 2024, www.investopedia.com/ask/answers/071614/what-are-different-types-private-mortgage-insurance-pmi.asp. Accessed 27 Dec. 2024.
Frankel, Matthew. "How to Buy Home with Little, No Money Down." USA Today, 7 Dec. 2016, www.usatoday.com/story/money/personalfinance/2016/12/07/how-buy-home-little-no-money-down/94991148. Accessed 27 Dec. 2024.
"What Is Private Mortgage Insurance (PMI)?" Zillow, www.zillow.com/learn/private-mortgage-insurance. Accessed 27 Dec. 2024.
"What to Know about Private Mortgage Insurance." Fannie Mae, yourhome.fanniemae.com/buy/private-mortgage-insurance. Accessed 27 Dec. 2024.