Are you buying a house and putting down less than 20%? Are you refinancing but have less than 20% equity? Whether you’re buying or refinancing, are you getting a conventional loan? Then you will need PMI.
What is PMI?
PMI stands for Private Mortgage Insurance. It protects the lender from losing financially if you default on your mortgage. Loans with higher loan-to-values have higher risks of default. Therefore, lenders require this insurance to make them whole in case you stop making your mortgage payments. If lenders didn’t have PMI on your loan, they would be reluctant to make your loan at 90% or 95% loan-to-value. PMI lets them offset the risk inherent in higher loan-to-value loans.
What is a Conventional loan?
A loan that’s sold to Fannie Mae or Freddie Mac. Conventional loans are different from government loans like FHA loans or VA loans.
What’s the difference between an FHA loan and a Conventional loan?
FHA allows as little as 3.50% down for the purchase of 1-4 family homes, whereas conventional loans only allow 3% down if you’re buying a single family home and are a first time homebuyer. FHA also allows lower credit scores and higher debt-to-income ratios than conventional loans. In general, underwriting is easier with an FHA loan, but FHA loans are often tougher on the collateral (i.e., the property you are buying). An FHA appraisal will often have a “punch list” of items that need to be fixed or repaired before you can go to closing.
If you’re putting down less than 20%, are you better off with an FHA loan?
Not necessarily. With FHA, you still need mortgage insurance, but it’s not called PMI – it’s called MIP (Mortgage Insurance Premium). You pay the MIP every month along with your principal, interest, taxes and home insurance, just like you would pay PMI every month with a conventional loan. If you were buying a house for $300,000 and putting down 3.50%, the monthly MIP would cost 85 basis points which works out to $205.06 per month on your loan of $289,500.
But with an FHA loan, you also have to pay something called UFMIP or upfront mortgage insurance premium at closing. It’s 1.75% of your loan amount so in the example above, your UFMIP would cost $289,500 x 1.75% or $5,066.25!! You can finance it (i.e., add it to your loan amount) but you’re still paying it. That’s why most people try to fit into the guidelines of a conventional loan.
Who gets PMI? Can you shop around for it like with Home Insurance?
Your lender gets it for you. You cannot shop around for it. Same with FHA mortgage insurance.
Who issues PMI policies? My brother is an insurance broker. He works with all the big insurance companies. Can the lender get it through him?
No. Lenders get PMI through a PMI company like MGIC, Genworth, Radian, Essent, or Arch Capital.
How much does it cost?
There are a couple of different ways of paying PMI, but most lenders select “zero monthly” which means you pay zero monthly up front PMI payment at closing.
The cost of PMI depends on your loan-to-value and credit score. If you have a credit score of 720 and are buying a house for $300,000:
- You are putting down 10%. Your loan-to-value is therefore 90%. Your PMI will cost $103.50 per month.
- If you decide to put down just 5% on the same house, your loan-to-value is now 95% and your PMI will cost $156.75 per month. The cost of the PMI is higher for two reasons – your loan-to-value is now 95% (not 90%), and your loan amount is higher ($285,000 vs $270,000).
Is PMI tax deductible? How about FHA MIP?
Yes, but there are certain restrictions. Check with your accountant to find out if you will be able to deduct mortgage insurance payments on your tax returns.
Does PMI pay off the loan in case I die before the mortgage is paid off?
No. That’s mortgage life insurance. You can get that type of insurance through an insurance broker. It will pay off the mortgage in the event of your death.
How long do you have to pay PMI?
PMI normally stays on your loan for at least two years. Then, once your loan is at 78% loan-to-value or less (either through your home increasing in value or through paying down the principal on your loan with your monthly payments), you can ask the company servicing your loan if you can drop the PMI. They will normally allow this once they have confirmed the loan-to-value which may involve a new appraisal.
How long do you have to pay mortgage insurance with an FHA loan?
It depends on your loan-to-value. If you are putting down 3.50%, the MIP stays on for the entire loan term. If you are putting down 10% or more, it stays on for eleven years.
How does PMI work with a refinance?
Let’s say you put down 20% when you bought your house three years ago. You paid $450,000 for it and got a loan for $360,000. Now you want to refinance, so you apply for a new loan. But when the appraisal comes back, it shows the value is now $425,000. Your loan-to-value is 84.7% instead of the 80% it was when you bought it. You now need PMI.
The opposite can also happen. Let’s say a friend of yours put down 10% originally when he bought his house for $350,000. He got a great deal on it and it was priced below market. He got a loan for $315,000 and he’s paying PMI. He applies to refinance, but when the appraisal is done on his home, the value has increased to $395,000. His loan is now at 79.7% loan-to-value. He no longer needs PMI.
What if you originally got an FHA loan and you refinance to another FHA loan — do you have to pay the UFMIP again?
Not if you meet the guidelines for a “Streamline Refinance”. FHA has a list of requirements for your loan to be considered a streamline refinance, but they are pretty straightforward, such as you need to have made six months of on time payments and can’t walk away from the closing with more than $500.
So if you need PMI, make sure you know all the facts!