What is private mortgage insurance (PMI)?

What is private mortgage insurance (PMI)?

If you look at your monthly mortgage statement and see a line for “PMI,” you’re paying for private mortgage insurance. It will probably cost you between $50 and $200 per month, depending on your loan balance and PMI rate.

But why are you paying for it? Your lender requires you to pay the premiums for an insurance policy that partially reimburses them in the event of a default on your mortgage. We’ll talk about when you’re required to have PMI, what this insurance protects, who should carry it, and ways to avoid paying for it.

Loan-to-value (LTV) ratio

The loan-to-value (LTV) ratio is what the lender looks at to determine whether or not you need to pay PMI and when you can stop paying it. To calculate this ratio, take the loan amount and compare it to the current value of your home. For example, if your mortgage is $150,000 and your home is currently worth $200,000, your loan-to-value ratio is 75%. When you buy a new home, your lender will look at the amount of your down payment compared to the sales price to determine your loan-to-value ratio. So if you buy a house for $200,000 and put down $20,000, your loan-to-value ratio is 90%. Generally, if your loan-to-value ratio is more than 80%, you will be required to pay PMI.

What is private mortgage insurance?

When you apply for a mortgage, the lender wants to make sure your home has enough equity to pay off the loan balance in the event of default and foreclosure. But since foreclosures on homes are often sold at a “discount,” lenders want a reserve of at least 20%. In other words, they want to be reasonably sure that they can get back the money they lent you if the house has to sell for less than the original asking price.

However, this does not mean that lenders are unwilling to lend when you drop less than 20%. They charge you more for the privilege through PMI. In this way, you obtain a mortgage and minimize the risk of offering you a loan. Private mortgage insurance is an actual insurance policy issued by an insurance company that benefits your lender. Suppose your home goes into foreclosure and the lender cannot recover the outstanding balance by selling the house. In that case, the insurance company that issued your PMI will pay the lender the difference.

PMI is called “private” because it is only offered to private companies and not government agencies or public mortgage lenders. Public programs, such as the FHA and VA mortgage programs, have their mortgage insurance, but it is managed differently and managed internally. However, one notable difference between PMI and the mortgage insurance associated with many FHA and VA loans is that the latter never expires. In other words, you will continue to pay mortgage insurance on FHA and VA loans even after your loan-to-value ratio has dropped below 80%.

Who needs private mortgage insurance?

In general, if your LTV ratio is less than 80%, you are free. However, if you have poor credit or are considered a high risk to the lender, you may need to carry PMI even with a 70%, 60%, or even 50% loan-to-value ratio.

You may be considered “high risk” if you have recently sold multiple homes, have been foreclosed on, or have unstable or undocumented income. However, this should be clearly stated in your loan documents, and if you’re not sure how it works, get a clear answer from your loan officer before you sign.

By aamritri

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