Private mortgage insurance (pmi)

Private Mortgage Insurance (PMI)

  • How long do you carry PMI?
  • Types of PMI
  • Cancellation of the PMI
  • PMI vs. MIP: The difference between private mortgage insurance and mortgage insurance premium
  • What affects the PMI rates?
  • How to avoid private mortgage insurance
  • PMI Strategies
  • Overall rating: the key to decision making
  • Another option: refinancing

Private mortgage insurance (PMI) is a special type of insurance policy provided by private insurers to protect a lender from loss if a borrower defaults. Most lenders require PMI when a home buyer makes a down payment of less than 20% of the home's purchase price – or, in mortgage terms, the loan-to-value (LTV) ratio of the mortgage is above 80% (the higher the LTV ratio) the higher the risk profile of the mortgage). PMI allows borrowers to obtain financing if they can only afford (or prefer) 5% to 19.99% of the cost of residency, but it comes with additional monthly costs. Borrowers pay their PMI monthly until they have accumulated enough equity in the home that the lender no longer considers them high risk.

PMI costs can range from 25% to 2% depending on the size of your down payment and mortgage (but usually approx. Be 0.5% to 1%) of your loan balance per year. The loan term and your credit score. The greater your risk factors, the higher the rate you pay. Also, because PMI is a percentage of the loan amount, the more you borrow, the more PMI you pay. There are six major PMI companies in the U.S. You charge similar rates that are adjusted annually.

How long do you carry PMI?

Once the mortgage's LTV drops to 78% – meaning your down payment plus the loan amount you repaid equals 22% of the home's purchase price – the lender must automatically cancel PMI, as required by the federal Owners Protection Act. , even if the market value of your home has decreased (as long as you are current in your mortgage).

Otherwise, the length of time you must carry PMI depends on the type of PMI you select.

Types of PMI

There are three different types of private mortgage insurance:

  • Borrower-Paid PMI (BPMI): you pay a premium each month until your PMI either terminates (when your LTV balance is expected to reach 78% of your home's original value) or when it is cancelled at your request. When a borrower has reached 20% equity in the home, he can notify the lender in writing that it is time to terminate PMI premiums. Lenders are required to provide the buyer with a written statement informing them how many years and months they will need to pay 20% of the mortgage loan, but due to an increase in home price (verified by an appraisal) because you have made additional principal payments. The lender should comply as long as the value of your home has not declined, you have a history of making timely payments, and you certify that you have no second mortgage or subordinate lien on the property.You can also request a cancellation or reach the midpoint of the amortization period (for example, a 30-year loan would reach the midpoint after 15 years).
  • Single Premium PMI : You pay the mortgage surcharge up front in a single lump sum, eliminating the need for a monthly PMI payment. The single premium can be paid in full at closing or included in the mortgage. While it requires more of a down payment, this option can save money for long-term homeowners.
  • Lender-Paid PMI (LPMI) : The lender pays the private mortgage insurance on behalf of the borrower. This can make for a lower monthly mortgage payment, but you may end up paying more interest over the life of the loan, especially since rates for this type of PMI are typically higher (since their cost is included in the mortgage interest for the life of the loan). Unlike BPMI, you cannot cancel LPMI because it is a permanent part of the loan.

Cancellation of the PMI

With BPMI, it's important to track your mortgage payments and your equity buildup. This 78% -threshold for automatic termination is based on the date the LTV is scheduled to reach 78%, according to your amortization schedule, not your actual payments. That is, if you have made additional payments and reached the 78% threshold early, your lender does not have to cancel the PMI by the originally scheduled date, which can result in you making months or even years of unnecessary PMI payments. (By law, lenders must inform you of your general right to cancel PMI, but not if you can do so in particular.)

You should also not trust that your equity in the property has reached 20%. of the original purchase price or the current appraised value. If this is the case, you must apply for cancellation. To request a notice, you must be current on your mortgage payments and have a good payment record. in particular that you:

  • Not have made a payment that was 60 days or more past due within the first 12 months of the last two years before the cancellation date (or the date you request the cancellation, whichever is later) ; or
  • Has not made a payment that was 30 days or more past due within 12 months prior to the cancellation date (or the date you request cancellation, whichever comes later).

Paying your mortgage is not the only way to build the equity that will allow you to apply for cancellation. If you make improvements that add enough value to your home, you can also meet the required minimum. If you're doing a major renovation – for example, a significant kitchen remodel – run the numbers to see if you qualify for a written PMI cancellation request now.

Once PMI is cancelled, the lender cannot require further PMI payments more than 30 days after the date your written request was received or the date you met the verification and certification requirements.

PMI vs. MIP: The difference between private mortgage insurance and mortgage insurance premium

Technically, PMI only applies to conventional loans.Federal Housing Administration loans have their own mortgage insurance with varying requirements.

FHA loans are similar to PMI loans in that they require mortgage insurance to be paid by the borrower in addition to regular mortgage payments. This insurance, called mortgage insurance premium (MIP), however, requires a closing fee and a monthly premium for a set number of years; It is paid directly to the U.S. Department of Housing and Urban Development (HUD). FHA loans also differ in that they are available to borrowers with less than perfect credit, allow a down payment of only 3, 5% of the purchase price of a home, and cannot be used for investments or second homes.

MIPs are often made under the same terms as PMIs. However, your lender may be legally entitled to continue claiming it on your FHA loan under certain circumstances:

  • If you've made payments within 30 days late and more than 60 days late within the past two years, your lender may move on. Consider you a high-risk borrower. Your lender may come to the same conclusion if your current credit score is very low.
  • If you have a second mortgage, z. B. Have a home equity loan, on your property. The thinking is, if you have a higher debt-to-credit ratio, you are more likely to default on your obligations.
  • The value of your home has dropped dramatically since the FHA loan was first issued, so your LTV remains 80% or higher with its current market value.

What affects PMI rates?

  • Size of your down payment. PMI costs less when you have a larger down payment (and vice versa).
  • Your credit score. The higher your credit score, the lower your PMI premium will be.
  • Potential for real estate value appreciation. If you live in a market with declining property values, your PMI premium could be higher.
  • Loan type. Adjustable-rate mortgages (ARMs) require higher PMI payments than fixed-rate mortgages.
  • Borrower occupancy. If the financed property is owner-occupied (you live there), your PMI premium is lower than for a rental or investment property.

Let's say you have a 30-year 4. 5% fixed rate mortgage for $200, 000. Your monthly mortgage payment (principal plus interest) would be $1, 013. If PMI 0. 5% cost, you would pay an additional $1, 000 per year or $83. 33 each month, increasing your monthly house payment to $1,096. 70.

In many cases, single premium PMI is the cheaper option as long as you stay in the home for at least three years. For the same $200, 000 loan, you could save about 1. Pay 4% up front, or $2, 800 (compared to about $3, 000 after three years with monthly PMI payments).

How to avoid private mortgage insurance

No matter which type you choose, PMI is not cheap. (And don't confuse it with mortgage life insurance, which goes to you or your heirs to pay off your mortgage if you become incapacitated or die.The lender is the sole beneficiary of PMI.) However, there are ways to avoid this.

An alternative to paying a PMI is to use a second mortgage or piggyback loan. In doing so, the borrower takes out a first mortgage with an amount equal to 80% of the home value to avoid PMI, and then takes out a second mortgage equal to the sale price of the home minus the amount of the down payment and the amount of the first mortgage. For example, in an "80-10-10" piggyback mortgage, 80% of the purchase price is covered by the first mortgage, 10% by the second loan, and the final 10% by your down payment. As a result, the loan-to-value (LTV) of the first mortgage drops below 80%, eliminating the need for PMI. For example, if your new home costs $180, 000, your first mortgage would be $144, 000, the second mortgage would be $18, 000, and your down payment would be $18, 000.

Of course, there is a disadvantage : a second mortgage in most cases will have a higher interest rate than the first mortgage.

PMI strategies

How to choose between these two basic options – use a "stand-alone" first mortgage and pay the PMI or use a second mortgage? There are several variables that can play a role in this decision, including:

  • The monthly numbers: Are the combined first and second mortgage payments less than the first mortgage payments plus PMI?
  • The tax savings associated with paying PMI are the tax savings associated with paying interest on a second mortgage. U.S. tax law allows the deduction of PMI only for certain income levels, such as families earning less than $100,000. In contrast, there are typically no restrictions on deducting regular mortgage interest.
  • The different rates of principal reduction of the two options.
  • The time value of money.

However, the most important variable in the decision is:

  • The expected rate of home price appreciation

For example, if the borrower uses a stand-alone first mortgage and pays the PMI instead of using a second mortgage. To eliminate PMI, how quickly could the home appreciate in value until the LTV is at 78% and PMI can be eliminated? This is the deciding factor.

Overall rating: the key to decision making

The deciding factor is that once PMI is eliminated from the stand-alone first mortgage, the monthly payment is less than the combined first and second mortgage payments. Here's how we ask the questions, "How long will it take to eliminate PMI??" and "What savings are associated with each option?"

Below are two examples based on different estimates of the rate of home price appreciation.

Example 1: A slow rate of home price appreciation
The following tables compare the monthly payments of a stand-alone 30-year fixed-rate mortgage with PMI compared to a 30-year first fixed-rate mortgage along with a 30-year/maturing second mortgage.

Mortgages have the following characteristics:

Figure 2 estimates the annual rates of home price appreciation.

Note that the $120 PMI payment drops from the total monthly payment on the stand-alone first mortgage in month 60, as shown in Figure 3. Reduction and house price increase.

The table in Figure 4 shows the combined monthly payments of the first and second mortgages. Note that the monthly payment is constant. The interest rate is a weighted average. The LTV is only that of the first mortgage.

The first and second mortgages can save $85 per month for the first 60 months. This equates to a total savings of $ 5, 100. From the 61. Month, the stand-alone first mortgage receives a benefit of $35 per month for the remaining mortgage terms. If we divide $5, 100 by $35, we get 145. In other words, in this slow home price appreciation scenario, starting in month 61, it would take another 145 months before the payment benefit of the stand-alone first mortgage without PMI could regain the original benefit of the combined first and second mortgages. (This time period would be extended if the time value of money were taken into account.)

Example 2: A fast rate of house price evaluation
The following example is based on the same mortgages as shown above. However, the following estimates are used to estimate the homeownership price.

In this example, we show only a single table of monthly payments for the two options (see Figure 6). Note that in this case, the PMI would be paid off in 13. Month because of the rapid appreciation of the home price falls, which quickly lowers the LTV to 78%.

If home price appreciation is rapid, PMI can be eliminated relatively quickly. The combined mortgages have only an $85 payment advantage for 12 months. This corresponds to a total savings of 1 020 US dollars. From the 13. Month, the stand-alone mortgage has a $35 payment advantage. If we divide $1, 020 by 35, we can see that it would take 29 months to offset the initial savings of the combined first and second mortgages. In other words, starting at the 41. month, the borrower would be financially better off if he opts for the independent first mortgage with PMI. (This time period would be extended if the time value of money were considered.)

Another option: refinancing

After a few years, homeowners may have another option to get rid of PMI: Refinance. If you feel your home's value has increased, a new loan can be less than 80% of the home's value, which means you don't have to pay PMI. While this can help homeowners, it's important to do a number of crunching up front to make sure the refinance makes financial sense. For example, interest rates may have increased significantly since your purchase.In general, it can be a good move if you can refinance at a low, lower interest rate and get rid of PMI at the same time.

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