How PMI Works (Private Mortgage Insurance Explained) ­­

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Preparing to become a homeowner is an exciting financial milestone, but the homebuying process is full of curveballs and complex processes that can make it a challenging feat. Buying home mortgage insurance is one obstacle that you may encounter when buying your first home—or secondary home(s), for that matter.

Lucky for you, we’re here to demystify the concept of mortgage insurance. In this post, we’ll discuss what mortgage insurance means in the general sense, who needs to pay for it, discuss different types of policies, define private mortgage insurance, and more. Use the links below to navigate throughout the article, or read all the way through for a more in-depth view of home mortgage insurance.

What is Mortgage Insurance?

Mortgage insurance protects mortgage lenders who lend money to homebuyers that pay a low down payment, typically a down payment that’s less than 20%. In fact, many conventional mortgage lenders require consumers to buy private mortgage insurance if their downpayment is at or below the 20% threshold. Every lender—and loan type— has unique processes and requirements when it comes to mortgage insurance, so be sure to ask your prospective lender about their protocol before making your final decision.

How does mortgage insurance protect lenders? Let’s say you make a 10% down payment on a home, and so your lender required you to make mortgage insurance payments on top of your loan balance because the equity you have in your mortgage is minimal. Later on down the road, you end up defaulting on your mortgage, meaning that you can no longer continue to pay your balance back to the lender. This is where mortgage insurance comes in handy for your lender. Using the funds from your escrow account, your mortgage lender pays the mortgage insurer the premium which can make up for some of the loss they’ve incurred.

As far as benefits for the consumer go, they’re relatively limited since mortgage insurance is designed to protect lenders, not the individuals borrowing money. Having mortgage insurance as a homebuyer basically just adds onto what you already owe on your mortgage. However, once you’ve paid off at least 20% of the mortgage, you can likely cancel your private mortgage insurance. We’ll discuss how to get rid of your PMI a little later on in this post.

Types of mortgage insurance

There are several types of mortgage insurance that lenders can choose to require in an effort to protect their investment interests; private mortgage insurance is just one of them. Before we dive into the specifics of PMI, let’s briefly define the other mortgage insurance types.

Private Mortgage Insurance (PMI)

Private mortgage insurance is a type of mortgage insurance that is sold through private insurance providers. We’ll go into more specific detail about PMI in later sections, or, click here to jump ahead.

Mortgage Insurance Premium (MIP)

Mortgage insurance premium is a type of mortgage insurance that is typically leveraged on FHA (Federal Housing Administration) loans. MIPs are either calculated as an upfront cost or broken down into monthly installments to be paid by the borrower.

What is Private Mortgage Insurance (PMI) and How Does it Work?

Private mortgage insurance (PMI) is just a type of mortgage insurance that lenders can leverage to protect themselves from potentially risky loan agreements. If your lender requires you to purchase PMI, they’ll typically make the arrangements for you and pair you up with a private insurance provider who you’ll make your mortgage insurance payments to. The most common way borrowers make PMI payments is with their escrow account.

Why do you need PMI insurance?

As we briefly mentioned, mortgage insurance is designed to protect mortgage lenders, not consumers. However, PMI can open up opportunities for prospective homebuyers that may not be able to afford a 20% down payment.Bottom line: paying money on top of your mortgage payments isn’t necessarily ideal as far as budgeting goes, but your lender may require this of you to limit their risk.

Types of private mortgage insurance

There are several different types of PMI that your lender can leverage. Depending on the kind of private mortgage insurance you have, you may remit payment to the insurer on your own, or your lender may handle that for you, or your PMI policy might fall somewhere in between. Let’s go over each to give you a better idea of what you can expect with each type of private mortgage insurance.

Borrower-paid mortgage insurance

Borrower-paid mortgage insurance is private mortgage insurance that is paid by the loan borrower. This is typically factored into your monthly payments or calculated in escrow.

Single-premium mortgage insurance

Single-premium private mortgage insurance is when the borrower can pay the cost of the premium as a lump sum up front, instead of paying it month over month.

Split-premium mortgage insurance

Split-premium PMI allows the homeowner to pay a portion of their mortgage insurance balance at closing.

Lender-paid mortgage insurance

Lender-paid mortgage insurance is when the lender pays for the mortgage insurance, and typically passes down the cost to the homeowner.

Private Mortgage Insurance FAQs

Now that you know what private mortgage insurance is and how it works, let’s dive a little bit deeper into this type of mortgage insurance by answering some frequently asked questions.

Who has to pay for private mortgage insurance?

Private mortgage insurance is generally required on conventional loans when the loan borrower puts a down payment of less than 20% of the home’s sale price.

What is the cost of PMI?

Borrowers who are required to purchase PMI can expect to pay approximately 0.5-1% of the loan amount annually. However, this number varies by lender. Ask to see your lender’s PMI chart to help you calculate how their private mortgage insurance requirements will impact your mortgage expenses.

How long do I have to pay for private mortgage insurance?

According to the Consumer Financial Protection Bureau, there are three circumstances that enable consumers to stop paying for PMI, thanks to federal protections:

  • Borrowers can stop paying when they have reduced their principal balance to 80% before the amortization of the loan. In other words, when they’ve put at least 20% down on the home earlier than the original loan terms. In this case, the borrower could request that the PMI be cancelled early.
  • PMI is automatically scheduled to cancel once you are scheduled to pay down 78% of your mortgage’s principal balance. However, you still need to meet certain criteria like being up to date on your payments.
  • PMI is also terminated once you reach the midpoint of your mortgage’s amortization schedule (for a 30-year loan, the midpoint would be year 15). This happens whether or not you’ve reached the 78% point.

How do I get rid of PMI on my mortgage?

If you want to get rid of PMI payments ASAP, reaching the 20% equity point is probably your best option. Plus, establishing equity in your home means you’re steps closer to paying off your mortgage! However, certain lenders have prepayment penalties you should be aware of when coming up with a plan to pay your mortgage.

Final Notes

If you’re thinking about buying a home in the near future, keep these high-level notes about private mortgage insurance in mind:

  • Private mortgage insurance (PMI) protects lenders, not homeowners.
  • PMI is often required for homebuyers who pay a down payment of less than 20%.
  • There are several different types of private mortgage insurance, including, borrower-paid, lender-paid, split-premium, and single-premium. Check with your lender for details on how they handle PMI.
  • PMI costs are typically passed down to the homeowner whether or not it’s considered lender-paid.
  • Once you’ve reached 20% equity in your home or meet other special requirements, you can typically cancel your private mortgage insurance.

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