f you’ve been thinking about buying a house for a while, you may have come across the term “private mortgage insurance,” or PMI for short. If you’ve heard other homeowners talk about it, they may have made it sound like a bad word.
What is private mortgage insurance? Let’s take a look.
What is Private Mortgage Insurance?
To help us understand PMI, let’s talk about what insurance is.
When you have car insurance, you’re protecting yourself from financial loss, right? You pay a premium every month to an insurance company. If something happens and you get in a wreck, your financial obligations are greatly reduced because the insurance company will bear the brunt of the costs.
Home insurance is the same way. You pay into it every month. If something happens and a lot of your property (both the home itself and possessions within) is damaged, the insurance company will cover most of the costs.
Private mortgage insurance is a form of insurance that protects the mortgage lender. You, the homeowner, pay a premium every month. This premium is on top of the regular mortgage payment.
PMI payments typically come out to between 0.25% to 2% of the mortgage balance per year, according to Investopedia. That means if you took out a loan for $300,000, the PMI would typically be between $750 to $6,000 per year.
Why Do You Need to Pay Private Mortgage Insurance?
Why is it that some homeowners have to pay PMI but others don’t? Is it based on credit score? Home value? If you’re a first-time homebuyer? Your interest rate?
Nope – none of those matter. There are really only two things that factor into this.
Factor #1: Mortgage Type
What kind of loan did you apply for? Some loans, such as VA Loans, don’t require PMI. If you applied for a conventional loan, you may end up having to pay the monthly premiums. It all depends on the next factor .
Factor #2: Down Payment
Have you ever heard that you should save up at least 20% for the down payment of a home? The main reason for that is so you can avoid private mortgage insurance.
When you put down at least 20% on the purchase of the home, you’re increasing your equity in the home and taking on some of the risks. If the lender ends up foreclosing on the house because you stopped paying your monthly payments, you’re out the 20% you’d put on the home initially.
If you don’t put down at least 20%, that means the lender is taking on more of the risk. If they have to foreclose on the home, they may not be able to sell it at a price that will let them recoup how much they’d loaned you. That’s why they charge private mortgage insurance. Those extra premiums help them deal with the additional risk they’ve taken on.
How Do You Get Rid of PMI?
Once you take out a conventional loan and are paying PMI, there are two main ways you can stop paying it.
Method #1 is to pay off enough of the loan. When you pay off enough of the loan that it’s 80% of the original appraised home value, you can ask your lender to remove PMI. When the balance of your loan gets down to 78%, the lender has to stop charging PMI.
Why does this work? Because you now have more equity in the home.
Method #2 is to get a new loan, such as buying another home or refinancing. As long as you can put down at least 20%, you can get out of your PMI.
Do you have any other questions about private mortgage insurance? Just let us know! We’d be happy to help in any way we can.