What is PMI?
How Does it Affect My Mortgage Payment?
It turns out that the whole home buying process can actually be really complicated all by itself.
When you add in the mortgage application process you may as well multiply that confusion by two, if not more. So today I wanted to try and make it a little less confusing for you by going over one of the terms that you will probably see as you go through the whole process: PMI.
PMI stands for “private mortgage insurance”. Never heard of it? That’s okay. Most first-time home buyers haven’t.
Definition
Private Mortgage Insurance is a special type of insurance that home buyers may be required to buy while purchasing their home.
Usually when someone is putting less than a 20% down payment on a house with a conventional loan, the lender that they are working with requires that they purchase PMI.
Even though the home buyer is the one that usually pays for PMI, the lender is the one that benefits from it.
Because low down payments — those that are below 20% — are considered a much higher risk for lenders, private mortgage insurance premiums are required to help mitigate their risks. To put it simply, PMI is there to protect lenders in the event that the home buyer stops making mortgage payments all together.
Types
Now you may already be familiar with paying for other types of insurance. Generally, you’ll have an annual or semi-annual premium that you need to pay. You then get the option to choose to pay a lump sum or to pay in monthly installments. PMI is similar in that sense, although there can be differences depending on the type of PMI that your lender requires you to purchase.
The most common type of PMI that you’ll run into is borrower paid. Borrower Paid PMI is paid monthly by the home buyer. This continues until the LTV ratio reaches 78%, meaning that 22% of your original principal loan balance has been paid off. So if you originally took out a mortgage loan of $100,000, then your borrower paid PMI would automatically fall off after you’ve paid $22,000.
By law you may also request to have your PMI removed even earlier, once your LTV reaches 80%. Some loan servicers may even allow you to apply to cancel your PMI if you’ve gained equity from the market value of your home increasing. If that doesn’t turn out to be option, then you may be able to refinance your home to remove the PMI.
Lender Paid PMI
Lender Paid PMI is mortgage insurance that is paid by the lender instead of the home buyer. With this type of PMI you usually have to pay a higher interest rate, and the PMI itself is amortized into the loan. Because of this, the only way to drop this type of PMI is to refinance.
MIP
MIP is a special type of mortgage insurance used specifically for Federal Housing Administration Loans — aka FHA Loans.
If you have a down payment greater than 10% of the loan, MIP will expire after 11 years. If you had a down payment of less than 10%, then MIP will last for the life of the loan. The only way to remove MIP from an FHA loan with a down payment less than 10% is to refinance.
Single Premium PMI
Single Premium PMI is another type that is actually a little bit different. Instead of paying monthly after the loan is closed, the insurance premium is paid in full at one time. Home buyers can pay cash at closing, or the premium can be rolled into the mortgage itself.
Split-Premium PMI
Split-Premium PMI is a sort of hybrid or mix of two types that I covered earlier. Instead of monthly or in a lump sum, you actually do both. At closing a home buyer would pay a large portion of the insurance PMI upfront and then continue to make smaller monthly payments after closing.
Affordability
No matter which form of PMI you end up with, it’s important to remember that it does affect your monthly mortgage payment.
It’s very common for people who are new to the home buying process to think that their mortgage payment is made up of just principle and interest. After all, those are the only things that many popular online mortgage calculators show — but that’s not the case.
In actuality, mortgage payments are made up of principle, interest, property taxes, homeowner’s insurance, and PMI.
PMI alone can increase a mortgage payment by several hundred dollars, depending on the size of your loan. So don’t be shocked if your payment is higher than you originally thought it would be. Better yet actually, make sure to communicate with your lender to fully understand potential costs during your loan application process.
They say knowledge is power and I really have to agree.
When you’re armed with knowledge about PMI and the options for removal, you’re armed with the tools to help you form a strong financial plan.
Before committing to anything, really think about your needs. How long are you going to be living in your new home for? How much of a monthly payment are you comfortable with? Do you want to prioritize smaller monthly payments or do you need to keep your closing costs lower instead?
These are just a few things to really consider, but there are probably much more. Your financial needs are as unique as you are, so take your time.
Oh Hey, It’s Ray is a real estate investor, entrepreneur, and former real estate agent. She lives happily with her husband and two children in the Pacific Northwest. See more from Ray at her YouTube channel and on Ohheyitsray.com