When it comes to the world of real estate, there is a lot of research that goes into buying a home. So if you’re thinking about purchasing a home and decide to apply for a mortgage, here’s what else you need to know. Most lenders require a 20% down payment on the purchase price of the home; but what happens if the borrower can’t afford it? This is where Private Mortgage Insurance can come into play.
What is Private Mortgage Insurance?
Private Mortgage Insurance, or PMI is a type of mortgage insurance that is required if the home buyer puts less than 20% down on a house. The PMI protects the mortgage lender from loss if the buyer stops making payments on their loan and the home is foreclosed.
How PMI Works
When a lender is in the process of underwriting your mortgage, they look into various risk factors. One of the measures of risk that lenders use is the loan’s loan-to-value ratio which divides the amount of the loan by the value of the home. If the LTV is greater than 80%, most lenders require the borrower has a PMI since the risk factor for them to default on the loan is high.
A PMI is added to the monthly mortgage payment or can be paid all at once at the time of closing. The PMI is not permanent and can be dropped from the monthly mortgage payments once a borrower pays down enough of the mortgage’s principal. If a borrower is current on their payments, the lender must terminate the PMI on the date that the loan balance is scheduled to reach 78% of the original value or in other words, when equity reaches 22%. Another alternative is if a borrower pays the amount of principal equivalent of the 20% down payment toward the loan, they can contact the lender and request that the PMI be removed.
Types of PMI
Borrower-Paid Mortgage Insurance
- This is the most common form of PMI and comes in the form of a monthly fee in addition to your mortgage payment. With BPMI you will pay the additional fee until there is 22% equity into your home based on the original purchase price.
Single-Premium Mortgage Insurance
- With single-premium mortgage insurance, also called single payment mortgage insurance, the buyer chooses to pay the entirety of the mortgage insurance upfront. The buyer can choose to do this by refinancing the insurance into their mortgage or by paying it all upfront at closing.
Lender-Paid Mortgage Insurance
- With lender-paid mortgage insurance the lender will technically pay for the cost of the mortgage insurance but you will also be paying for it over the life of the loan at a higher interest rate.
Split-Premium Mortgage Insurance
- This type is the least common of the four and is a combination of borrower-paid and single-premium. With split-premium, you will pay half of the PMI in a lump sum at closing and the other half of the PMI will be distributed over monthly payments.
Advantages and Disadvantages of paying PMI upfront
Paying your PMI upfront has both benefits and drawbacks. Let’s take a look at both so that you can make a better educated decision.
- Your PMI is taken care of at closing. This means you no longer have to worry about additional monthly payments, but you will be paying for all of it at once in addition to the other closing costs.
- No additional monthly charges with your mortgage payment. By paying the lump sum upfront, the lender will not charge a monthly PMI premium on top of your monthly mortgage.
- Don’t fret about PMI cancellation later. With monthly payments, borrowers can request PMI cancellation once they earn enough equity but by paying PMI upfront you don’t need to worry about this task.
- Paying PMI upfront means you will owe more at closing in addition to the closing costs.
- If you choose to refinance your mortgage or sell your home, you will lose the money that you paid upfront for the PMI.
- You will not be able to deduct monthly PMI payments in your taxes.
Whether you choose monthly payments, to pay upfront or a combination of both; Private Mortgage Insurance has been beneficial to many individuals when it comes to buying a home. Homeownership comes with a set of new responsibilities and we applaud you for researching the process. When it comes to the unknowns of homeownership, let our knowledgeable team at Metropolitan Title assist you along the way.