What is PMI or Private Mortgage Insurance? You hear this term tossed around quite a bit in the world of real estate. However, most people aren’t quite sure what it means or know if it’s a requirement.
Private Mortgage Insurance
PMI, also known as Private Mortgage Insurance, is a type of mortgage insurance you may be required to get if you have a conventional loan. This typically comes into play if you are putting less than 20% down on a home. With a smaller down payment, the loan is considered to be higher risk from the bank’s point of view. Private mortgage insurance serves as a form of security for lenders, in the event of defaulted loans.
How Much Is PMI?
Does PMI really affect your monthly payment? In short, yes. Although there’s not a set formula for how PMI is calculated, there are several variables that will determine your monthly rate.
First, down payment is a major factor at play. Having a 4% down payment versus a 16% down payment will likely result in a higher monthly premium. The less money down, the higher risk your loan appears. Because of this, banks will require more insurance to guarantee they are covered.
Second, credit score will be factored into the equation. During the loan application process, the bank’s system communicated with mortgage insurance companies. It imports a quote based on loan amount, credit score, and down payment. Lower credit scores indicate higher risk. In our experience, we’ve seen calculated payments as high as $350 a month. This added monthly expense can also affect your approval rating.
Third, loan amount is a consideration when calculating PMI. Banks are in the business of getting their money back. A high loan amount means the bank has more of their money at risk. Combine that with a low down payment and they need more coverage in case you default on your mortgage. This results in needing more insurance, meaning a higher monthly payment.
How To Get Rid Of PMI
Prior to 2015, PMI would automatically drop off once you had enough equity in your home. As the value of your home increased and the amount owed got paid down, the bank would become more comfortable with your loan-to-value ratio and no longer require private mortgage insurance. It still exists with a conventional loan that the PMI will fall off once you hit a certain amount of equity in your home.
For instance, if you’ve been making your monthly mortgage payments for a few years. Perhaps a relative passed away and you inherited money that you put toward paying off the home. Lenders are typically looking for you to have 20% equity in your home in order for that PMI to disappear.
Presently, with an FHA loan, mortgage insurance is on there for the life of the loan. You can eliminate this by one of two ways: sell your home or refinance. However, in order to refinance, you’ll still need to be at that 20% equity mark.
Equity is the percentage of your principal balance that you’ve paid off. This is not to be mistaken for payment that has gone toward paying interest. You cannot build equity by paying off interest. In other words, you may want to consider making extra payments toward principal if you want PMI gone as soon as possible.
Once you’ve gained enough equity in your home, contact your lender and begin the process of filing refinance documents. A financial expert will make sure you qualify. After approval, you’ll receive a closing disclosure. This document contains your new loan terms, where you’ll want to verify the PMI has, in fact, been removed.
LPMI stands for Lender Paid Mortgage Insurance. This is essentially a separate loan where the lender pays your mortgage insurance. The benefit to this is that PMI is not a factor in your monthly payment. The trade off to the lender paying your insurance is that they’ll give you a little bit of a higher interest rate. The LPMI program usually comes into play when a borrower can’t get approved for a conventional loan with the private mortgage insurance payment attached to it. This is largely due to lack of income qualification. Therefore, they create the home loan and PMI loan separately to get you approved. This is a fantastic option in a strong seller’s market where buyers are having to use their cash to go over asking and in turn, have smaller down payments.
About The Author
The team at My Front Range Living are a group of full time real estate experts serving Colorado Springs, El Paso County and the surrounding areas. Their knowledge of the local community and experience in the industry provide you incomparable value when buying or selling a home. With several years of experience in helping out of state buyers and sellers, they are the go-to team when it comes to relocating and helping Colorado feel like home.
Even if you’re looking for an agent in another city or state, the My Front Range Living team has a network of experts that can connect you with the right professional.
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