The Types of Private Mortgage Insurance (PMI) Explained

Written by Posted On Wednesday, 03 February 2021 13:05
What is Private Mortgage Insurance What is Private Mortgage Insurance

Private Mortgage Insurance Explained

If you are just about to put a deposit down on your new home and hope to avoid PMI (Private Mortgage Insurance), you will usually need a 20% deposit for a traditional mortgage.

You may need to keep some money for essential renovations or not have enough money available. When you borrow money for your mortgage and have a deposit of less than 20%, the loan to value ratio will be over 80%.

This presents a higher risk for the lender. If the house unexpectedly has to be sold in the first couple of years, they may not get their money back. Many first-time buyers ask what is PMI. They are either told by their real estate agent or mortgage broker to expect to pay this mortgage fee with a small down payment. You avoid paying PMI when you have a twenty percent down payment.

Let's take a look at what you need to know about PMI. It will also be worth your time to take a look at the excellent resource from Maximum Real Estate Exposure on how you can get private mortgage insurance terminated.

What is PMI?

If you have to take out PMI, it does not protect you. It is purely to protects the lender's investment in your home. On the other hand, the homeowner has some advantages as it allows people to buy with a smaller deposit, sometimes only 5%.

The rate that property prices are rising would indicate an advantage in buying now with a 5% deposit, not in five years when you have a 20% deposit saved (especially if real estate has had another meteoric price rise).

However, the PMI will incur an additional monthly cost for you until your home's equity is high enough to be no longer considered a risk to the lender. So all this must be weighed up before proceeding.

Types of PMI and Costs Involved

There are four types of PMI that you can purchase, and they are:

  • Single-premium mortgage insurance.
  • Borrower-paid mortgage insurance.
  • Lender-paid mortgage insurance.
  • Split premium mortgage insurance.

The borrower has to pay for the insurance to compensate the lender for taking the risk of loaning them the money when the borrower only has a small deposit. It is all about the degree of risk involved.

Types of Private Mortgage Insurance Explained in Detail

Borrower Paid Mortgage Insurance

This is the most common one, where the borrower pays a monthly fee. You keep paying it every month until you have 22% equity in your home based on your house's original price. This can take more than 10 years to reach, if you have a good repayment history, you can ask your lender to cancel the BPMI when your equity reaches 20%, but they will probably require a home appraisal, which you will be asked to pay.

If you are in a rising market, it is worthwhile having a valuation done after 5 years. The other option if you get a higher valuation is that it may be worth refinancing the loan. Weigh up the costs and decide what is best for you and your family.

Single-Premium Mortgage Insurance

With Single-Premium mortgage insurance, the amount is paid in a lump-sum when signing up for the loan. The downside is if you sell the house after a few years, there is no refund on the insurance. Not all lenders offer SPMI.

Lender-Paid Mortgage Insurance

This sounds good as the lender pays upfront, but you pay for it over the loan term with a higher interest rate. You will continue to pay, even when you have equity in your home as it is built into the term of the loan. So you will need to refinance to get a better deal when your equity has increased past 22%. This insurance is not refundable.

Split Premium Mortgage Insurance

Split-Premium Mortgage Insurance is a mixture of the first two insurances and works by paying part of the mortgage insurance as a lump sum and the rest as a monthly premium. The monthly premium is based on an initial loan to value ratio. The split-premium may be partly refundable once canceled.

Federal Home Loan Mortgage Protection (MIP)

This type of mortgage insurance is underwritten by the Federal Housing Administration (FHA loans). It is a requirement when the deposit paid is 10% or less. This payment is usually added to the monthly mortgage and can't be removed or canceled for 11 years.

What's The Cost of Private Mortgage Insurance?

This will depend on several factors, and it may take a bit of sifting through to decide on the right course of action.

  •  Interest rate, is it fixed or adjustable?
  • Loan term 15 years 20 years or 30 years.
  • Payment to deposit to loan value ratio.
  • Amount of coverage required by the lender.
  • Your credit score. Having an excellent credit score is essential when buying a home.
  • Whether the premium is refundable or not.

The risks are weighed up by the lender with all the above factors taken into account. The PMI can be as high as 2.25% of the original amount borrowed each year. So to work out what you will pay, take a look at the mortgage insurance rate cards. This is what you do:

  • Find the column nearest to your credit score.
  • Find the row that matches your LTV ratio.
  • Search the web, Fannie Mae's Insurance Coverage, to work out the amount of coverage you require for your loan.
  • Go back to the card and identify the rate corresponding with your credit score, deposit, and coverage.
  • Follow the steps to complete your calculation, and ask your lender to check it.

This way, your rate will be the same each month, and after 10 years, some insurers will lower it.

Federal House Administration FHA Mortgage Insurance

This insurance works differently, and for many borrowers, it will end up more expensive than PMI.

Since August 2020, there is an upfront premium of 1.75% of the loan. When you settle up for the loan, you can pay this or roll it into your mortgage. Of course, financing attracts interest on the amount, making it more costly.

With the FHA mortgage, you will pay a monthly insurance premium of 0.45% to 1.05 % of the loan. This is based on your deposit and loan terms—this type of loan suits people whose credit score is too low to qualify for other finance types.

Final Thoughts on Private Mortgage Insurance

Mortgage insurance is costly for those with a small down payment or deposit. For many, the benefit of having their own home and the security it brings outweighs the cost. Unfortunately, it is one of those necessities that will get you into a home.

It is vital that you consult with a mortgage broker to see what mortgage program works best for your particular financial circumstances. Choosing the right financing package can save you tons of money over the time period you hold the loan.

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Bill Gassett

One of the top RE/MAX agents in New England over the last decade plus. Providing exceptional real estate services to buyers and sellers in the Metrowest Massachusetts area including the following communities: Ashland, Bellingham, Douglas, Framingham, Franklin, Grafton, Holliston, Hopkinton, Hopedale, Medway, Mendon, Milford, Millbury, Millville, Northborough, Northbridge, Shrewsbury, Southborough, Sutton, Wayland, Westborough, Whitinsville, Worcester, Upton and Uxbridge MA.

See my real estate website at Maximum Real Estate Exposure - one of the most visited real estate sites in Massachusetts.

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