Learn about what Private Mortgage Insurance (PMI) is and why you may need it.

If you’ve been considering buying a home, you may have heard the term Private Mortgage Insurance, often referred to as PMI. But what is PMI? Understanding what PMI is and how it works can save money and help you approach the mortgage process with more confidence.  

What is PMI?

September 6, 2016

Learn about what Private Mortgage Insurance (PMI) is and why you may need it.

If you’ve been considering buying a home, you may have heard the term Private Mortgage Insurance, often referred to as PMI. But what is PMI? Understanding what PMI is and how it works can save money and help you approach the mortgage process with more confidence.

 

What is PMI?



When buying a home, you will need a down payment. Your down payment is referred to as a percentage of the total appraisal value or sale price, such as 10% or 20% down. If your down payment on a conventional loan is less than 20%, you will need to get Private Mortgage Insurance (PMI). The same rules apply for those refinancing a home with less than 20% equity. When a borrower doesn’t have a large down payment, more risk is placed on the financial institution. PMI is used to protect the lender in case of default on the home payments. This way, if the home goes into foreclosure, the lender has a buffer of funds to help them recoup the cost of the mortgage.

Let’s say you are buying a $100,000 home. If you put less than $20,000 down on the home, you will need to purchase PMI. This is because you will be financing more than 80% of the cost of the home. For instance, if your down payment is only $10,000, you will be financing 90% or $90,000.

You can also look at it through the loan-to-value (LTV) ratio. This ratio is calculated by taking the amount of your mortgage and dividing it by the value of your home. Using the same example as above, if your mortgage is for $90,000 and your home is worth $100,000, your loan-to-value ratio is 90%. Any mortgage with a loan-to-value ratio over 80% will need PMI.

 

How is PMI Calculated?



There are three factors that affect your PMI rate:

  • Amount of down payment
  • Loan term
  • Credit score

 

How Long Must You Have PMI?



You must pay for PMI for as long as your loan-to-value ratio is more than 80%. Using our same example, your PMI payments would continue until your mortgage balance drops to $80,000. Once you hit the 80% loan-to-value ratio mark based on the original value of the loan, you can request that the lender remove the PMI. Automatic termination of PMI coverage can occur on the date which the principal balance of your mortgage is scheduled to reach 78% of the original value of your property. Learn more about removing PMI here.

At your home closing, your lender will provide you with paperwork that explains how long you will need to make PMI payments based on your mortgage. If you want to speed up this process, you can put down a larger down payment or increase your mortgage payment each month. The faster you reach a loan-to-value ratio of 80%, the less you will pay in PMI.

 

Why Would You Want PMI?



  • PMI can help you get the home you want if you don’t have a large down payment
  • May be tax deductible*
  • Can help you qualify for a loan you wouldn’t be able to otherwise

 

How to Avoid PMI



If you don’t have the full 20% down but would like to avoid purchasing PMI, you can look into a Combination Mortgage. This type of mortgage allows you to put as little as 5 or 10% down without having to pay PMI. Essentially, you are financing the balance of your 20% down payment with another loan.

Saving up a down payment of at least 20% is another way to avoid PMI. It may seem hard, but using some of these strategies can help you get there and avoid adding PMI to your mortgage bill.

 

Have a mortgage or PMI question? Let us know in a comment below!

 

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Equal Housing LenderThis credit union is federally insured by the National Credit Union Administration.

Redstone is an Equal Credit Opportunity Lender.

This content is provided for informational and educational purposes only and considered accurate as of the date posted. Views and opinions expressed in comments do not constitute an official endorsement by Redstone Federal Credit Union® or its affiliates. Redstone encourages you to seek professional advice for your personal situation before making any financial decision and is happy to assist you at any of our branch locations.

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Mortgages are only available for properties located in Alabama and Tennessee.

*Consult your tax advisor regarding the deductibility private mortgage insurance premiums.

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