Buying A Home Home Loans

Private Mortgage Insurance Explained

One of the most important things you’ll need to plan for if you’re buying a home is how much you’ll pony up for the down payment. If you’re getting a conventional loan, the standard 20% of the purchase price is what you’ll need if you want to get around paying private mortgage insurance or PMI. If you’re clueless about what PMI is or how it affects the cost of buying, read this first before you sign off on a mortgage.

What Is Private Mortgage Insurance?

Homeowner’s insurance protects you and your property against fire, theft and natural disasters while PMI is a policy that covers the lender. Specifically, private mortgage insurance is designed to reduce the loss to the bank if you default on your loan and the house ends up in foreclosure. As the homeowner, you’re responsible for paying the premiums but you don’t actually gain any benefit from having the policy.

Private mortgage insurance premiums are normally built into your monthly mortgage payment. The amount you actually have to pay is based on a few different factors, including:

  • The length of your mortgage loan
  • The type of loan you have
  • Your credit score
  • The minimum coverage required by the lender
  • The size of your down payment

Typically, your PMI premiums will run anywhere from 0.3% to 1.15% of the amount you borrow. That’s something you need to keep in mind as you’re mapping out your home-buying budget. Having to add in PMI payments might mean lowering your estimate of how much mortgage you can afford.

When is PMI Required?

Generally, your lender will require you to purchase a private mortgage insurance policy any time you’re buying or refinancing a home that you have less than 20% equity in. The easiest way to get around having to pay is to put at least 20% down on any home you buy but that’s not always realistic for every buyer.

You’re also obligated to pay private mortgage insurance premiums with USDA and FHA loans. That’s because these loan options require no down payment and a 3.5% down payment respectively. With either loan, you’ll pay an upfront mortgage insurance premium that’s included with your closing costs and an annual insurance premium that’s rolled into your payment.

As of 2016, USDA home-buyers are subject to an upfront insurance premium equal to 2.75% of the loan amount and a 0.50% annual premium that’s divided into 12 monthly payments each year. The upfront premium for FHA loans is 1.75% of the borrowed amount and the annual premium is 0.85%.

How Can You Get Rid of PMI?

While having to pay private mortgage insurance can be a downer, you’re not necessarily stuck with it forever. If you have a conventional loan, your lender is required to drop your PMI coverage once you hit the 78% percent loan-to-value ratio mark. Once your equity reaches 22%, you can walk away from paying PMI for good.

If you’ve got an FHA or USDA loan, on the other hand, it’s not so simple. Going forward, new loans originated under either program are subject to the upfront and annual mortgage insurance premiums for the life of the loan. As someone who recently closed on an FHA loan, that means the only way I can get rid of those premiums is to refinance into a conventional loan at some point.

While that gives me an out, I’d still have to have at least 20% equity built up to get around paying PMI with a conventional loan. The takeaway here? Your best best for keeping your mortgage costs as low as possible is to save up a 20% down payment so you don’t have to get private mortgage insurance in the first place. If funds are tight, check out one of the thousands of down payment assistance programs out there to see if you can score some financial help with buying your home.

About the author

Rebecca Lake

Rebecca Lake is a personal finance writer and blogger specializing in topics related to mortgages, retirement and business credit. Her work has appeared in a variety of outlets around the web, including Smart Asset and Money Crashers. You can find her on Twitter at @seemomwrite or her website, RebeccaLake.net.

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