What Is PMI and Do I Have to Have It?

Alright, you have selected the house you want to buy, found a mortgage lender to meet your financing needs and they have presented you with a rate quote that looks pretty enticing. You love the offer, and your dream of homeownership is coming to close but there’s just one thing. You notice an extra charge on the monthly payment labeled PMI. What is that?

Private Mortgage Insurance – PMI – lowers the risk to lenders making loans to borrowers in case of a default. This insurance does not cover the consumer at all, only the lender. This allows lenders to safely extend credit to borrowers who generally would not qualify for that particular program.

PMI will be required on most loans when a borrower does not put down at least 20% of the purchase price of a home. The extra monthly fee also increases the overall cost of your loan. The insurance can be found on three major loan types: USDA, FHA and Conventional Loans.

Conventional Loans

For conventional loans, lenders will use private mortgage insurance to help cover themselves in case of default. The monthly premium of the PMI will be based on the borrower’s credit score and down payment.

Typically, Conventional PMI rates are between .55% and 2.25% of the loan amount. In most cases, these rates will be cheaper than FHA loans and conventional loans will not require an upfront premium for the PMI.

Once a borrower hits 80% loan to purchase value on their principal balance, they can request the mortgage company to drop the PMI. The insurance must legally be dropped once the loan to value reaches 78%.

In order to prevent PMI, the borrower must put down at least 20%. The only way to avoid monthly PMI payments is by choosing lender paid PMI, in which the lender removes the PMI in exchange for a higher interest rate.

FHA Loans

FHA mortgage insurance premiums (MIP) are paid directly to Federal Housing Administration and is required on all mortgages backed by the organization.

FHA requires an upfront mortgage insurance premium of 1.75% of the loan balance on all loans and a monthly rate between 0.45% and 1.05% depending on the down-payment for the loan.

If a borrower puts down less than 10% on an FHA loan, they must carry mortgage insurance for the life of the loan. Putting down more than 10% will allow the borrower to cancel mortgage insurance after the first 11 years.

If a borrower does not have the funds to cover the required upfront mortgage insurance premium, they can roll the fee into the loan.

In order to get rid of mortgage insurance, borrowers typically refinance the loan when the principal balance reaches 80% of the home’s value.

USDA Loans

USDA loans are like FHA loans when it comes to mortgage insurance, however the terminology is different. USDA calls their upfront fee a guarantee fee and its mortgage insurance is labeled as an annual fee that’s billed monthly.

The annual fee is .35% of the principal loan balance and the upfront fee is 1% of the loan amount. Unlike FHA and Conventional loans, the borrower must pay the annual fee for the entire life of the loan.

The only way to get rid of the annual fee is by refinancing once the loan balance decreases below 80% of the home value.

Calculating PMI

In order to determine your required upfront payment and monthly payments, you take your loan balance and multiply it by the upfront premium percentage or monthly rate percentage. In order to get the monthly payment, divide the multiplied figure by 12.

For example, if you are buying a $300,000 home with an FHA loan, to get the upfront mortgage insurance premium you multiply $300,000 by 1.75% to get a total upfront premium of $5,250. The monthly rate is calculated by multiplying $300,000 by 1.05% and then dividing by 12 to arrive a monthly MI payment of $ 262.50.

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