What is Private Mortgage Insurance?

Looking to get a mortgage? It's possible you've come across the term "private mortgage insurance." It can be a complicated concept to understand, but it's essential to become familiar with PMI and what it means for you, the borrower.

What is PMI?

Private mortgage insurance is a risk management tool for lenders. Typically, lenders will require that high-risk borrowers secure PMI before the loan is made. Thus, PMI protects the lender if mortgage payments are defaulted on. It's important for prospective homeowners to know that PMI cannot be used to help them if they encounter financial trouble. 

When is PMI required? 

Generally, lenders will require private mortgage insurance from borrowers who make a down payment of less then 20%. That threshold is the industry standard, and if you commit less than 20%, that means the lender is taking on greater risk in making the loan. Any costs related to PMI are paid directly to the lender.

Is PMI required for all types of loans?

PMI is often attached to conventional loans, those that are made by commercial lenders and which are not backed by the government. And while a lower-than-average down payment may trigger PMI, there are different products that may offer reduced down payment expectations without requiring PMI. For instance, some loan products may have a higher interest rate, but do not mandate PMI.

It's also worth noting even some federally backed mortgages may ask that borrowers pay PMI.

What factors into the cost of PMI? 

Many of the same factors that determine your mortgage approval will decide the PMI rate. Lenders will take into account credit score, debt-to-income ratio, local housing market health, lender policies, financial history and the size of the mortgage. 

PMI can range between 0.3% and 1.5% of the original loan amount. In general, the lower the down payment, the higher the PMI rate may be. In any case, if you're required to carry PMI, the lender must disclose its effects on your loan estimate.

PMI can be paid in two main ways: as part of the monthly mortgage payment, or as an up-front sum. Sometimes lenders will offer other payment options, so make sure to ask any lender you work with.

What are the pros and cons of PMI?

There is an upside to private mortgage insurance for the borrower: The addition of PMI may qualify you for a mortgage that you would not have otherwise been able to secure.

That said, PMI can represent a significant added cost. If you're applying for a mortgage worth $250,000, a rate of even 0.7% could mean $1,750 in PMI costs for the year. That leads to each monthly mortgage payment being increased by $145 with the addition of PMI. 

Can I avoid PMI?

Because PMI can represent such a substantive cost to borrowers, it's valuable to explore all scenarios in which you could avoid PMI. These may include:

• Waiting to purchase a home so more savings can be built up to either bypass PMI entirely, or lessen its cost.
• Targeting less-expensive homes.
• Building up equity in the home. If your mortgage originally required PMI, you have cancelation rights once you've accrued enough equity in the property.

Need to learn more about PMI and what mortgage options are available to you? Talk to a local Vectra Bank rep today.