How does PMI work on a conventional loan?
PMI is an acronym for private mortgage insurance. Many people confuse PMI with MIP (mortgage insurance premium). There is a difference. Private mortgage insurance is associated with "conventional" home loans. MIP relates to the government-backed FHA and USDA loan programs.
PMI is not life insurance. People often mistake mortgage insurance with mortgage life insurance that pays off the mortgage should the owner(s) pass away.
If you’re taking out a conventional mortgage and have less than a 20% down payment, the mortgage company will most likely require you to purchase “private mortgage insurance”. When a borrower does not have the twenty percent down payment, the lender reaches out to a "private mortgage insurance" company. The private mortgage insurance company will guarantee the lender the difference between the buyer's down payment and the required 20%. For example, if you have a 5% down payment, the mortgage insurance company will insure or guarantee the down payment shortage of 15% to the lender. Now when a foreclosure occurs, the lender seeks reimbursement from the mortgage company for the down payment shortfall (i.e. 5% down payment + 15% guaranteed by the private mortgage insurance company).
There are 4 PMI payment options
1. Monthly plan (also known as borrower paid MI)
The monthly PMI plan is the most popular payment plan. The following examples assume a $200,000 purchase with a 30-year term with a "fixed" interest rate. adjustable-rate mortgages have a higher cost factor.
Here's an example of the monthly PMI premium. Notice how the monthly premium decreases as the down payment increases.
Down Payment Percentage | Loan Amount | Credit Score | Cost Factor | MONTHLY COST |
|---|---|---|---|---|
3% | 194,000 | 700 | 0.99% | 160.05 |
5% | 190,000 | 700 | 0.78% | 123.50 |
10% | 180,000 | 700 | 0.55% | 82.50 |
15% | 170,000 | 700 | 0.25% | 35.42 |
2. Borrower paid single premium
The single premium PMI is a lump-sum payment at settlement. The single premium option can also be financed in the mortgage. The single premium choice does not require additional payments to the private mortgage insurance company. The single premium can be used in conjunction with the seller paid closing costs.
The single premium is offered as refundable and non-refundable. The refundable option means that if the loan is paid off early, a percentage of the single premium will be refunded to the borrower. The non-refundable choice does not refund any unearned premium, if the loan is paid off early. The non-refundable single premium is less expensive.
Down Payment Percentage | Loan Amount | Credit Score | Cost Factor | One time payment |
|---|---|---|---|---|
3% | 194,000 | 700 | 3.18% | 6,169.20 |
5% | 190,000 | 700 | 2.52% | 4,788.00 |
10% | 180,000 | 700 | 1.75% | 3,150.00 |
15% | 170,000 | 700 | 0.71% | 1,207.00 |
3. Split premium
The split premium option combines the monthly premium and the single premium plans. With the split premium selection, the borrower(s) pay a percentage of the mortgage insurance at settlement and a reduced amount each month. As the upfront percentage increases, the monthly payment decreases.
Down Payment Percentage | Loan Amount | Credit Score | Upfront Premium Factor | Monthly premium factor | One time payment | Monthly payment |
|---|---|---|---|---|---|---|
3% | 194,000 | 700 | 0.50% | 1.06% | 970.00 | 171.37 |
5% | 190,000 | 700 | 0.50% | 0.76% | 950.00 | 120.33 |
10% | 180,000 | 700 | 0.50% | 0.47% | 900.00 | 70.50 |
15% | 170,000 | 700 | 0.50% | 0.10% | 850.00 | 14.17 |
4. Lender paid mortgage insurance (LPMI)
With this choice, the lender pays the premium for the mortgage insurance. But there's a catch, the lender increases the interest rate to cover the mortgage insurance cost. You knew there had to be a catch.
Piggyback loan
There is one more way to avoid the dreaded mortgage insurance cost. It's called a piggyback loan. It can also be called a combo loan or tandem loan. Regardless of the name, here's how a piggyback loan works. The loan amount is broken up into two loans. The 1st loan amount is 80% of the loan, and the balance (after the down payment) rides in as a 2nd mortgage. Is your head spinning? Here's an example. Let's assume that the purchase price is $200,000 with a 10% down payment. An example will help:
Sales price = $200,000
Less 10% = $20,000 (down payment)
Loan amount = $180,000
SALES PRICE = $200,000
1st mortgage - $200,000 X 80% = $160,000
2nd mortgage - $200,000 less $20,000 less $160,000 = $20,000 (2nd mortgage)
The 2nd mortgage, usually an equity loan is a tactic to reduce the overall cost.
Is this approach better than one of the traditional PMI plans? It might be. Ask the loan officer give you a comparison quote to determine which choice is beneficial.
Frequently Asked Questions About PMI
Q. How long does it take to go away?
A. We'll use an example to estimate the number of years it will take to eliminate the PMI cost. Assume a purchase for $200,000 and a mortgage of $180,000 (10% down payment) at 5% for 30-years. It will take about 10 years and 6 months to pay the loan down to $160,000 (20% equity). To determine the payoff date for your mortgage; use an amortization calculator (they're everywhere) and multiply the sales price by 80% to arrive at the payoff date.
Q. How much is PMI on an FHA loan?
A. The upfront premium is 1.75% of the loan amount. The monthly cost varies with the down payment and loan amount. SeeFHA funding fee and MIP explanation
Q. How to get rid of PMI?
A. See How to get rid of the PMI on your mortgage
Q. How to remove private mortgage insurance on an FHA loan?
A. After June 3, 2013, you are not able to remove the MIP if your mortgage was a term greater than 15-years (i.e. 30-years) and the down payment was less than 10%. For FHA loans with a down payment of 10% to 22%, the MIP can be canceled after 11 years. See FHA funding fee and MIP explanation
Q. When is private mortgage insurance required?
A. PMI is required when the loan amount is greater than 80% of the sales price or appraised value, whichever is less. Simply divide the loan amount by the sales price/appraised value to determine the loan percentage. For example, if the loan amount is $90,000 and the sales price was $100,000, divide $100,000 by $90,000 and the loan percentage is 90%. Any number greater than 80% will require PMI.
Q. Who pays for private mortgage insurance on a mortgage?
A. The buyer (or homeowner if the new loan is a refinance). The home seller is permitted to pay the private mortgage insurance.