Dear Friends, I am often asked about PMI. I get a lot of great questions, such as:
1. What exactly is PMI?
2. How much does it cost?
3. How do I avoid PMI or cancel PMI on my loan?
4. Will a Lender really pay for my PMI?
Here are some answers to these questions:
1. What is PMI? Private mortgage insurance (PMI) does not insure you, or your home, as a homeowner’s insurance policy would. Private Mortgage Insurance, or PMI is for insuring “conventional” mortgage loans. The majority of conventional mortgage loans with less than 20% equity have 4 components as part of the total monthly payment: (1) principal & interest, with additions to escrow being: (2) property taxes, (3) homeowner’s insurance, and (4) Private Mortgage Insurance, or PMI. “Private mortgage insurance (PMI) protects the lender if you stop making payments on your loan. Lenders may (or most always) require you to purchase PMI if your down payment is less than 20 percent of the sales price or the appraised value of the home. PMI premiums are added to your monthly mortgage payment. You may be able to cancel private mortgage insurance after a few years based on certain criteria, such as paying down your loan balance to a certain amount.” This quote was taken from the Consumer Financial Protection Bureau website
2. How much does PMI cost? The cost of PMI is based mainly on (A) credit score, and (B) down payment, or LTV on a refinance. The theory here is that as a borrower’s credit score is higher and/or there is more equity in the property, the PMI company assumes less risk. The less risk the PMI company undertakes, the lower the PMI rate. See PMI Company – “Radian’s,” PMI Rate chart for a 30 year fixed rate mortgage. As you can see, with 95% financing (5% down payment) and a credit score between 700-719, the conventional borrower would have a PMI rate of .87%. This means, that on a $100,000 mortgage, they would pay $870 per year in PMI, which would be divided out by 12 payments and added into their escrow as $72.15 per month (that’s slightly more/mo. than a buyer with a 620 credit score would pay for monthly mortgage insurance on a FHA loan). However, if this conventional borrower had a credit score of 760 or higher, and was putting 10% down (90% LTV), they would be given a PMI rate of .30%. Thus, they would pay $300 per year on a $100,000 loan. Likewise, this $300 per year in PMI would be divided out by 12 payments into their escrow to add only $25.00 per month. But, remember… unlike home owner’s insurance, this Private Mortgage Insurance (PMI) does not insure you for anything – it insures the Lender.
3. How do you eliminate or cancel PMI? One can eliminate PMI from the very beginning of their mortgage by putting a down payment of 20% or more. If they are refinancing, PMI will not be required if their newly refinanced loan is 80% or less of their appraised value. If a home owner already has PMI on their mortgage, it will automatically cancel after they pay down their mortgage balance to 78% of their initial purchase price. For example, if someone were to purchase a home for $100,000 and initially finance $90,000, they might pay “Basic PMI” which would be automatically terminated when they have paid their mortgage down to $78,000. However, a homeowner can request cancelation of their current PMI earlier than the paying down to 78% of their original purchase price if their home has appreciated enough in value to prove 20% equity. To See information from the Consumer Financial Protection Bureau (CFPB) on how to request cancelation of your current PMI, or when it may automatically terminated, see PMI cancelation/termination.
Side note: due to the surprising low interest rates we are currently seeing in the market as of today, February 5, 2015, and the combination of rising home values we’ve had over the past few years, many people are refinancing their homes. In this process many people are able to reduce their PMI thanks to a new appraisal that shows more equity, and even eliminate their PMI if their appraisal shows they have 20% equity or more. By combining the reduction or elimination of PMI with a lower interest rate, many homeowner’s are now able to save on both a for a win/win.
4. Will a Lender Really pay your PMI? The quick answer to this is yes. But, is there a catch? Well, or course… Here’s how: a lender can self-insure the mortgage with “Lender Funded” or “Lender Paid” PMI. The PMI is essentially paid from the borrower by paying a higher interest rate. The higher rate charged by the Lender for this “Lender paid PMI” will depend on factors such as loan amount, credit score, and down payment. For example (and this is just an example, and not necessary exact numbers), a borrower with a 679 credit score who is putting 10% down, may be charged an extra 0.750% on his or her interest rate for “Lender paid PMI.” So, instead of paying the PMI separate in his or her escrow, a borrower with “Lender paid PMI” might pay 4.50% for their 30 year fixed interest rate, instead of 3.75%. But, just as the “Basic PMI” rate drops for larger down payments and higher credit scores, so will the “Lender paid” PMI allow for a better interest rate with larger down payments (more equity) and/or higher credit scores. Compared to the 679 credit score/10% down buyer that is charged an extra 0.750% to his or her interest rate; a 760 credit score/15% down buyer may be only charged an extra 0.250% for his or her interest rate with “Lender paid PMI.” Again, these are just some examples, and not necessarily exact percentages as more precise information is usually required by the Lender to allow for a “Lender paid PMI” quote.
The main advantage of the “Lender paid PMI” is that the borrower will actually have a lower payment when compared to the “Basic PMI” that is added to the total payment through the escrow account.
The main disadvantage of “Lender paid PMI” is that it cannot be eliminated once the home owner achieves 20% equity – it is forever part of the (higher) rate as long as the home owner keeps that mortgage. When eliminating the “Basic PMI,” this home owner will eventually end up with a lower payment in the long run since they should have received a lower interest rate to begin with, compared to the interest rate they would have received with the “Lender paid PMI.”
In determining which PMI may best for you could come down to a prediction of how long you think that you may live in the home? The longer you plan to stay in the home, the longer time you would have to take advantage of appreciating home values, and hopefully cancel your basic PMI coverage early. This would also mean that you would have a longer time to save money after your PMI is canceled since you should have received a lower interest rate, compared to the “Lender paid PMI” interest rate that stays with the loan.
Disclaimer: The interest rates mentioned in this blog, and the adjustments for Lender paid PMI rates are not intended to be rate quotes. They are listed are for the purposes of examples and discussion purposes; and therefore, do not include an APR as more information would be needed such as the day of the rate quote, loan amount, loan term, loan amount, etc.
