This is not the same as Homeowner’s Insurance which covers the property in the event of fire, theft, etc. PMI or Private Mortgage Insurance is a coverage mandated by a Lender anytime you, the borrower, do not have 20% equity in the transaction. This is the case if you are buying a home and are unable to apply 20% of the Sales Price as down payment. When refinancing, the same is true if the amount of the loan will be more than 80% of the appraised property value. This ratio is referred to as the Loan to Value (i.e. The amount borrowed out of the total value or price, whichever is lower.)
What does this Insurance actually cover?
What it’s actually covering and protecting against is the potential loss the Lender would take in the event you default on your payments and the home gets repossessed. Lenders are taking a larger risk when they lend out more than 80% of the home’s value. The process of foreclosure is quite expensive and if not for Mortgage Insurance like this the Lender would lose a substantial amount by taking a bet on you with such little skin in the game.
LOAN AMOUNT / APPRAISED VALUE or SALES PRICE = Loan-to-Value Ratio
Ex: $30,000 down on a $200,000 price home worth $210,000… $170k / $200k = 85% LTV
Do I have to pay PMI?
Like other insurances such as Flood or Homeowner’s coverage PMI is paid through the borrower’s monthly payment. If the mortgage type is Conventional, PMI will be required until the loan balance has decreased to 80% LTV or less. Also for Conventional Mortgages the PMI can be dropped after a the borrower has paid the loan down to less than 80% Loan to Value. So in the event you can put 15% down payment, it will not take long to get to the same point you would have been putting a full 20% down.
What if I want an FHA Loan or USDA (Rural Development) Loan?
FHA & USDA’s loan programs do not allow you to cancel the Mortgage Insurance. Instead that coverage is paid for the life of the loan. Meaning that once you drop below 80% LTV, you would then need to refinance to a different mortgage like a Conventional in order to cancel the monthly expense. Refinancing will then cost another set of Closing Costs including a new appraisal.
At the time of writing this article, USDA (RD)’s mortgage insurance is relatively cheaper than FHA’s. Conventional mortgage insurance is based on many factors including the borrower’s credit score, LTV, Debt to Income, etc. FHA’s MI however is standardized and does not cost more if the borrower’s score is lower. While VA Loans do not have a monthly MI to be paid and only have an UpFront Premium.. More on UpFront Premiums in a moment.
Here’s a Pro/Con way of looking at each:
I’m not endorsing one loan type or another, just laying out the facts to let you decide what fits you the best.
Conventional Mortgage PMI: is cancellable once LTV is 80% or less. Costs more if score is not top tier, and is more costly the less the down payment is. So someone putting 5% down on Conventional will pay more in PMI than someone putting 10% down. There is no UpFront Premium on these.
***It should be noted that a common myth about Conventional Mortgages is that people thing you have to put 20% down to go with Conventional but this is not true. Often times someone can put 5% down or as little as 3% down depending on income level and whether they are a “first time buyer”.***
FHA Mortgage Insurance: monthly insurance is not cancellable and must be paid for the life of the loan. FHA includes a 1.75% Upfront Premium which can either be paid along with Closing Costs or rolled into the loan amount. (Ex: $180k Price with FHA’s 3.5% down payment, would have an upfront premium of roughly $2600 rolled in).
USDA (Rural Development) Mortgage Insurance: monthly insurance is not cancellable and must be paid for the life of the loan. The upfront and monthly cost is less than on FHA. USDA includes a 1.0% Upfront Premium which can either be paid along with Closing Costs or rolled into the loan amount. (Ex: $180k Price with USDA’s 0% down payment, would have an upfront premium of roughly $1,800 rolled in.)
VA (Veteran’s Affairs) Mortgage Insurance: does not have a monthly Mortgage Insurance but does have a Upfront Premium referred to as the “Funding Fee”. This fee is calculated based on several factors including whether the applicant has purchased a home using the VA program previously.
In Summary:
To sum it up, there will be many who cannot afford to put a whole lot down on a home and will therefore pay some sort of Mortgage Insurance. However, my advice is that if you can take time to budget and save more, correct issues on credit, and research what’s involved in the mortgage process. Then in the long run your wallet and your future self will thank you.