If you are purchasing or refinancing a home, you’ll need 20% down or 20% equity. Otherwise you’ll need private mortgage insurance, also known as PMI. PMI often has common misconceptions—PMI is often thought to protect the borrower, but in fact, it’s created to protect the lender. PMI is required on all government-backed mortgages. Since PMI is an expense to the borrower, it’s in your best interest to know about the best PMI options available, and how you can avoid PMI completely.
What Determines Your PMI Rate
Three factors determine your PMI rate. First is your Loan-to-Value (LTV) ratio. The lower your LTV ratio, the better PMI rate you will receive. The second factor is your credit score. A high credit score will result in a better PMI rate. The third and final factor is the loan program you select. Selecting fixed-rate mortgage over an adjustable-rate mortgage (ARM) will give you a lower PMI rate.
Available PMI Options
Obviously, the simplest way to avoid PMI is to to have 20% cash to put down for a purchase, or 20% equity if you are refinancing, but that’s not always possible. The most common form of PMI is paid monthly and included in your mortgage payment. However, growing in popularity is the one-time upfront premium. While this option doesn’t completely avoid PMI, the mortgage insurance provider normally discounts the cost of the premium if you pay for it in one sum, as opposed to monthly payments. An additional option is to utilize a lender-paid mortgage program (LPMI). LPMI works by the lender paying for the one-time, upfront insurance premium. The catch with LPMI is that the interest rate of the loan or refinance goes up for its entire lifetime. Even when you have paid 20% of the principal balance, you will continue to pay off the loan at the higher interest rate, because the lender paid for the PMI at the beginning. The final option is to avoid PMI completely, by taking out a second mortgage which enables your first mortgage to remain at 80% of your home’s value. This option is more commonly known as either an 80/10/10 or 80/15/5.
How to Eliminate PMI
The most straight-forward way to eliminate your PMI is to pay off the principal balance by 22%. With regular PMI, once the balance is 78% or less, the mortgage insurance will automatically terminate. If you have paid off 20% off your PMI (opposed to 22%), you can make a request in writing to your lender to eliminate the PMI. The lender’s decision will be based on a good history of mortgage payments, and providing evidence of no junior liens on the home. PMI will also automatically terminate when the loan has reached the halfway point of amortization. For example, if you have a 30-year mortgage, PMI will automatically end after 15 years. The catch to all of this though is to make sure your home’s value has not dropped. If the lender has reason to believe the home’s value has declined, your PMI could be extended. Lenders need to ensure the value of the home has not dropped due to the possibility of a foreclosure—if a foreclosure occurs, lenders don’t want to be stuck with a home that’s not worth the full value of the loan.
How to Choose Your Private Mortgage Insurance
When it comes time to make a decision about PMI, follow these steps to make sure you get the best deal:
- Price all three types of mortgage insurance: monthly, one-time upfront, LPMI PMI companies seek to have balance in their portfolio of loans. Therefore, when the popularity of a certain type of insurance drops, PMI companies often reduce the price or offer a special deal in order to get borrowers to sign up for that specific kind of insurance. That’s why borrowers need to research all three kinds of mortgage insurance, in order to know what’s currently the best deal.
- Ask other parties to pay for all, or part of the one-time upfront premium or LPMI On a purchase, ask the seller for concessions. Seller concessions are financial concessions used to pay mortgage closing costs. However, they can also be used to pay for mortgage insurance. For a purchase or refinance, negotiate with the lender to pay for part of the LPMI.
- Find a PMI Discount Varyingly, lenders will offer special deals involving mortgage insurance discounts. When lenders want to target a certain demographic, they’ll make an offer suited to that particular group of people. An example of an offer may be a home loan with only a 5% down payment and no mortgage insurance. Lenders work to subsidize the borrower’s mortgage insurance so it’s the lowest available. Special deals are typically segmented by region and loan program, so research special offers in your area.