PMI: Private Mortgage Insurance

Learn how Private Mortgage Insurance works, PMI Cost, how to Avoid PMI, and how to Cancel PMI

Private Mortgage Insurance ( PMI ) is mortgage insurance that refinance lenders require from individuals that borrow more than 80 percent of their home's value. It protects the mortgage lender from default on the loan and allows refinance and purchase mortgages at up to 100% of the value of the home. Mortgage Insurance is normally paid monthly by the borrower and included with the mortgage payment as a separate amount. So, with PMI, your total monthly mortgage payment can include Principle, Interest, Mortgage Insurance, Taxes, and Homeowner's Insurance. Beginning in 2007, private mortgage insurance is now a tax-deductible expense.

How Much Does PMI Cost?

PMI charges vary depending on the Loan-to-Value ratio and the size of the loan, and are calculated as a percentage of the loan amount. The higher amount that you borrow above 80% of your home's value in 5 percent intervals (ie: 80%, 85%, 90%, 95%, 100%), the higher the percentile used to calculate your monthly PMI payment. An 80% LTV may result in a .50 percent of loan amount for PMI, where a 95% LTV might result in a .75 percent of refinance loan amount for your mortgage insurance calculation. The average is typically around .70 percent as in the example below.

Example:

For instance, say that you are refinancing your home valued at $100,000 and your loan amount is $85,000. The refinance lender would multiply the $85,000 loan amount by .007, which results in an annual PMI of $595. Now divide the $595 by 12 to calculate your monthly PMI payment of $49.58.

How Can I Avoid PMI?

There are a few ways to avoid paying PMI. You can finance less that 80% of your home's value, take out a split loan, or choose a Lender Paid Mortgage Insurance (LPMI) loan option.

Finance Less Than 80%: I know this seems obvious, but many times, in a cash-out refinance scenario, the borrower is very close to that 80 LTV figure and may opt to take less cash in order avoid paying PMI. It's also important to note here that refinance lenders will require the borrower to escrow their taxes and insurance if they go over the 80 LTV. Escrow deposits will add to closing costs and present another consideration in addition to mortgage insurance when the borrower is near the 80 LTV.

Split Loan: The Split-Loan can be used to eliminate mortgae insurance. This option involves two loans, the first mortgage being at 80% of the home's value and the second loan typically at 10%, 15%, or 20% of home value. The second loan will be at a higher rate of interest than the first. You can add the two payments together and compare it against the "one mortgage only" option with PMI to judge the difference in savings.

The Split-Loan option is being used less and less today, as refinance lenders move away from second mortgages and split loan options. If you ultimately choose to go this route, make sure that you understand the terms of your second loan before you sign. Quite often, second mortgages are packaged as "interest-only loans", balloon mortgages, or variable interest loans that come due in 10 to 15 years. Saving a few dollars a month in PMI now may not be worth the future cost in interest and/or the hassle of satisfying the second mortgage when it comes due in 10 or 15 years. This is true, especially if your new first mortgage is a 30-year low fixed refinance loan, and you plan to stay in it for the entire term.

Lender Paid Mortgage Insurance (LPMI): With Lender Paid Mortgage Insurance, the refinance lender pays the private mortgage insurance for the borrower, but will result in a higher rate of interest for the individual. The total monthly payment with LPMI will usually be less than that of an identical LTV loan scenario mortgage payment with Borrower Paid Mortgage Insurance. The important difference between the two private mortgage insurance types is that LPMI cannot be cancelled by the borrower, and therefore is most suited to those that plan to be in their mortgage for 10 years or less. Borrower paid mortgage insurance can be cancelled as we see next.

Can I Cancel or Terminate PMI?

Yes you can. The Homeowner's Protection Act (HPA) of 1998, requires lenders or loan servicers to provide certain disclosures concerning PMI for loans secured by the consumer's primary residence obtained on or after July 29, 1999. Under HPA, you have the right to request cancellation of PMI when you pay down your mortgage to the point that it equals 80 percent of the original purchase price or appraised value of your home at the time the loan was obtained, whichever is less. You also need a good payment history, meaning that you have not been 30 days late with your mortgage payment within a year of your request, or 60 days late within two years. HPA requires refinance lenders to tell the buyer at closing how many years and months it will take for them to reach that 80 percent level and cancel PMI. Refinance lenders must automatically cancel PMI when the balance hits 78 percent.

Borrowers are advised to read and understand the lender provided disclosures regarding PMI before their refinance loan goes to close. Also, keep track of your payments on the principle of the mortgage so that you can contact your lender to cancel the PMI once your loan-to-value (LTV) ratio is at 80%.

HPA does allow lenders to continue allowing PMI to a 50 LTV for those borrowers in reduced-documentation mortgages, spotty credit histories, or individuals with high debt-to-income ratios.

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