Private Mortgage Insurance

When a home buyer’s down payment on a new home is less than 20%, the lender often requires they purchase private mortgage insurance, or PMI. Some borrowers choose to put less money down on a home in order to save cash for remodeling expenses or emergencies and therefore purchase PMI as well. 

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All mortgage lenders evaluate a prospective homeowner’s risk profile and any borrower with a down payment under 20% will end up with a mortgage loan-to-value ratio over 80%. Borrowers with a loan-to-value ratio over 80% are considered to have a high risk profile and their PMI provides protection for the lender on their investment. The PMI covers any delinquent interest that accrues on a property as well as foreclosure costs for the lender if the borrower cannot make their mortgage payments. 

When a home buyer's down payment is less than 20%, the lender often requites private mortgage insurance. Credit: Clay Banks/Unsplash

The PMI is beneficial for the borrower because it enables those unable to get financing due to a lack of cash reserves for a down payment the option to purchase a home sooner. 

Borrowers are required to pay their PMI each month until they have built up enough equity in their purchased property to remove them from the high-risk category. The cost of a PMI typically ranges from 0.5% to 2.5% of the loan’s balance depending on the insurance plan chosen, the tem of the loan, the borrower’s loan-to-value ratio, the borrower’s credit score and more. The higher the risk associated with the borrower, the higher the PMI. PMI rates are adjusted annually.

Lenders must cancel the PMI once the borrower’s loan-to-value ratio drops to 78% if mortgage payments are current. The loan-to-value ratio drops when the borrower’s down payment added to the amount of the loan principal that has been paid off is 22% of the home’s purchase price. This requirement is covered under the Homeowners Protection Act.  

There are five different types of PMI:

1. With a borrower-paid mortgage insurance,  the borrower pays a monthly fee on top of their monthly mortgage payment. This is the most common type of PMI. 
2. With a single-premium mortgage insurance, the insurance fee is paid in full either at the closing or financed into the home’s mortgage. 
3. The lender pays the insurance premium in a lender-paid mortgage insurance, but the borrower pays for it at a higher interest rate over the duration of the loan. 
4. The least common type is a split-premium mortgage, in which borrowers are required to pay part of the mortgage insurance at the closing in a lump sum and the other part monthly.
5. For borrowers who qualify for a Federal Housing Administration (FHA) loan, the  FHA mortgage insurance premium—referred to as MIP—is only used with FHA loans. The MIP is required for all FHA loans and when the down payment is less than 10%.