Home buyers have several monthly costs such as principal repayment, interest, property taxes, Home-owners Insurance, and HOA fees. However, there is one more component, Private Mortgage Insurance (PMI) which is paid if the down payment on the home is less than 20%. For example, if the final home price is $500,000 and the down payment paid is $75,000, that is 15% ($75,000/$500,000), PMI will be required. PMI can be anywhere in the range of 0.4% to 2.25% and is based on home price, down payment amount, credit score, and type of mortgage. There are five types of mortgage default insurance for home buyers.
- Borrower Paid Mortgage Insurance (BPMI) – This type of mortgage insurance is the most common and is used by the majority of home buyers. In this form of PMI, the mortgage premium is added to your monthly mortgage payments which include the principal, interest and other fees. There are 4 different ways of getting rid of your PMI once the loan starts:
- If you achieve 78% loan-to-value of the purchase price of the house – After making regular monthly payments when you reach 78% of loan-to-value PMI will be automatically removed by the insurer. For example, on a $500,000 home if you gave a down payment of $50,000, then your LTV ratio is 90% ($450,000/$500,000), once you have made enough monthly payment to get the loan value down to 78% of purchase price which is $390,000 ($500,000 * 78%), PMI will be removed. On a 30-year mortgage, this is usually achieved in 11 years. It can also be removed manually if you are current on your payments and get 20% ownership of the home, in this case, you have to reach out to your insurer.
- Pass the Halfway Point of the Mortgage Term – On a 30-year mortgage, once you cross 15 years, and have been making regular payments, PMI will be removed. Even if you have not reached 78% LTV, PMI will still be removed if the halfway point is crossed.
- Refinance Mortgage – In periods of low mortgage rates, it is in your benefit to refinance the mortgage to get a better deal. In this case, when you refinance, if you own 20% of the home, then the PMI will be removed.
- Home Appreciation – This point is beyond your control, but it is still valuable to know. If the home you are staying in appreciates in value such that the LTV ratio falls below 80%, PMI can be removed. For example, say you have made $15,000 worth of payments in 5 years on a home price of $100,000, your LTV is 85% ($85,000/$100,000), now if the home appreciated in those 5 years to $110,000, your LTV is 77% ($85,000/$110,000). You will require an official appraisal for this case.
- Single-Premium Mortgage Insurance (SPMI) – In this type of default insurance the home buyer can choose to pay the entire PMI in one go at the start of the loan. This form of single payment mortgage can be paid out at closing or financed into the mortgage such that the total mortgage amount increases. This form of insurance is not provided by all lenders so be sure to see if your lender offers SPMI.
There are certain advantages of using SPMI, such as smaller monthly payments because the PMI has either been paid or is spread out over the term of the mortgage. You won’t have to refinance just to get out of PMI and you do not need to track your LTV ratio constantly in order to stop paying PMI.
Disadvantages include that if you do refinance for other reasons such as low mortgage rates, the PMI will not be refunded even if you own more than 20% of the home. Similarly, if you decide to sell the home before the end of the mortgage, the PMI is lost. If you finance the single PMI into the mortgage, interest is paid on it for the life of the loan. Lastly, if a 20% down payment is not possible, in most cases it is difficult to pay the PMI as a lump sum at the beginning of the mortgage when savings are low.
- Lender Paid Mortgage Insurance (LPMI) – In this type of mortgage insurance the PMI is paid by the lender rather than you the buyer of the home. Essentially, the lender offers this form of PMI because in return they increase the mortgage rate on your loan, such that you have slightly higher monthly payments.
Advantages include lower monthly payments as compared to the first type of PMI – BPMI, despite a higher mortgage rate. As a result of which you can qualify for a larger loan. The disadvantages are that LMPI cannot be canceled or refuned even if you attain an LTV ratio of 78% as the higher mortgage rate is set at the beginning of the loan. The only way to reduce LMPI is to refinance the loan at a lower mortgage rate.
- Split Premium Mortgage Insurance – This type of default insurance is a combination of the first BPMI and the second type SPMI. In this case, you pay a certain amount of the total mortgage insurance as a lump sum in the beginning, and the rest of the PMI is spread over your monthly payments. Therefore, your monthly payments aren’t as high as BMPI and the initial required amount is lower than SPMI.
Split premium should be chosen if you have a high debt to income ratio, as BMPI will result in a lower qualifying amount as it increases monthly payments. The upfront amount will be approximately 0.5% to 1.25% of the loan amount and the monthly amount is based on the LTV ratio.
In conclusion, there are several options for home buyers regarding mortgage default insurance. BPMI is the most common and results in higher monthly payments, SPMI you need to have enough money saved at the start of the loan, LPMI results in higher mortgage rates, and lastly Split premium which is a combination of BPMI and SPMI. Therefore, it is best to determine what your financial needs are and which one can maximize your benefit for the lowest cost.