When mortgage lenders extend a loan to a future homeowner, they want to make sure that their profits are protected. If a homeowner is making a downpayment of less than 20% of the value of the loan, lenders often require that the borrower purchase a private mortgage insurance (PMI) policy.
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What Does Private Mortgage Insurance Cover?
PMI insurance policies cover the lender for part of the value of the loan principal that is yet unpaid in case the homeowner defaults on the loan and/or the property enters foreclosure.
While PMI insurance has the benefit of allowing people without the cash on hand to make large down payments to obtain affordable rates for mortgages, it can also help those who pay a smaller down payment for other reasons.
Future homeowners may decide to make a smaller downpayment than they can technically afford to have cash available for other expenses. Families purchasing a home at the lower end of their budget may plan to make immediate upgrades and want cash available for upcoming costs for remodeling, repairs, and furnishings.
For others, their particular situation may make it more prudent to have cash available for emergencies, regarding their home, their health, or other responsibilities in their life. There are different kinds of PMI policies, and future homeowners interested in putting a down payment under 20% of the loan should look into what PMI options are available to them.
What Kinds of PMI Policies Are There?
Borrowers whose lenders require them to purchase PMI coverage for their home do not have to carry this policy forever. Once their equity in the home is at least 20%, they can request that their insurer cancels the requirement.
Regardless of what the insurer wants, however, the federal Homeowners Protection Act insurers that, no matter what, the policy will be canceled once the homeowner has 22% equity in the home. Beyond the amount of the principle of the loan you’ve paid off, the type of PMI policy that you purchase can also impact how long you will need to maintain PMI coverage.
Borrower-Paid Mortgage Insurance (BMI)
BMI policies are the most common form of PMI, and these policies result in a separate, additional premium to your monthly mortgage payment.
Single-Premium Mortgage Insurance
This type of PMI allows you to make a single lump-sum payment at the time of the loan’s closing, which will avoid making your monthly payments higher but require you to sacrifice the amount of cash you have on hand when you close on your home.
Lender-Paid Mortgage Insurance
Another option is that your lender pays for the PMI policy in a lump sum in your place. The costs will then be incorporated into the loan itself as a higher interest rate. Your monthly payment will be lower than in a BMI policy, but you’ll likely pay more over the life of the loan due to interest and the payment can’t be canceled once your LTV is less than 78%.
For split-premium PMI insurance, you would pay a smaller lump sum at closing and the rest of the payment would be made monthly. Compared to the single-premium, this option would leave you with more cash on hand after closing and can sometimes be partially refundable once mortgage insurance is canceled when your equity in the home reaches 22%.
What Other Considerations Should You Be Aware Of?
For those who have mortgage loans underwritten by the Federal Housing Administration, there are special considerations that you should keep in mind when considering what your monthly expenses will look like. PMI policies for FHA loans is called a mortgage insurance premium (MIP).
If your mortgage is an FHA loan and your down payment was less than 10%, then MIP can’t be canceled without refinancing the loan. If your down payment was more than 10%, MIP must be paid for 11 years until it can be canceled.