Understanding Private Mortgage Insurance (PMI)

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Written by Andrew Pearsall - Mortgage Loan Officer, Evergreen Branch

While purchasing a home, a common term that you may hear is “Private Mortgage Insurance” or PMI. This is a very important concept to understand especially if you’re planning on financing your home with less than 20% down. Why does mortgage insurance exist and how does it affect the lender as well as the borrower?
What is PMI? PMI is to protect the lender not the borrower. It acts in a similar way that homeowners insurance protects the homeowner. When a borrower makes a down payment less than 20%, the lender in theory may be taking on a bigger risk. It can also vary depending on credit score. PMI helps mitigate that risk by making sure that the lender is compensated in case the borrower defaults on the mortgage.

How does it work?

  1. Down payment less than 20%: Whenever a borrower puts less than 20% down on their mortgage, the lender will traditionally require PMI. This applies for a conventional loan. No matter the loan to value an FHA loan will always have mortgage insurance.

  2. Monthly Premiums: PMI is a cost that is included in your monthly mortgage payment. These premiums can change depending on down payment and loan amount. 

  3. Building Equity: Once you have reached 20% equity in your home for a conventional mortgage, you can request the removal of PMI. 

  4. Automatic Cancellation: PMI will be automatically cancelled once you have reached the 22% equity mark on a conventional loan.

Ways to get rid of PMI

Getting rid of PMI can help to lower your monthly payments. Here are the ways to have it removed: 

  1. Build equity: Make payments until you reach 20% equity on a conventional mortgage. 

  2. Refinance: If you refinance your loan and you receive a lower loan-to-value ratio it could reduce or eliminate PMI. 

  3. Home Appreciation: If the value of your home increases, once more your loan-to-value ratio may naturally improve.

With all of that said, Private Mortgage Insurance (PMI) provides a level of safety to assist with mitigating the risk factor of loaning out funds. Borrowers who put less than 20% down on their conventional mortgage will need to pay PMI which can increase your monthly payment for your mortgage. Although, this can be a great way of obtaining a home without having to make a large down payment, understanding how this works can be pivotal in ensuring you are getting the most bang for your buck when purchasing and or financing your home. Make sure to always speak to your loan officer about the ways PMI may have impacted your loan or how much your PMI is calculated.

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