When buying a home, you may encounter private mortgage insurance, or PMI. PMI can be a valuable option for many borrowers who want to buy a home without a large down payment, but it does add an additional cost to monthly payments. In this blog, we’ll break down exactly what PMI is, how it works, what factors affect it, and types of PMI options available. Plus, we’ll share tips on how you can avoid PMI altogether.

What is PMI, and How Does It Work?

Private mortgage insurance, or PMI, is a type of insurance required by many lenders when a borrower’s down payment is less than 20% of the home’s purchase price. PMI protects the lender by covering a portion of their losses if a borrower defaults on their mortgage. Although PMI protects the lender, the borrower is responsible for the cost, typically added to monthly mortgage payments.

The cost of PMI can vary depending on factors like the loan size, your credit score, and your down payment. On average, PMI costs can range from 0.3% to 1.5% of the original loan amount per year. For example, on a $300,000 loan, PMI could cost between $900 to $4,500 annually, translating to roughly $75 to $375 per month added to your mortgage payment.

Factors That Affect PMI Costs

The cost of PMI is determined by several factors. Understanding these can help you estimate PMI costs and decide if avoiding it is worthwhile. Here’s what affects PMI:

1. Loan-to-Value Ratio (LTV): The LTV ratio compares your loan amount to the home’s value. The higher the LTV (the closer you are to 100% of the home’s value), the higher the PMI cost since it reflects greater risk to the lender.
2. Credit Score: Lenders view a higher credit score as a sign of responsible borrowing, which may result in lower PMI costs. Borrowers with lower credit scores, however, may face higher PMI premiums.
3. Down Payment: The larger your down payment, the lower the risk for the lender. If your down payment is closer to 20%, PMI rates may be lower compared to a smaller down payment.
4. Loan Amount: Larger loan amounts typically mean higher PMI costs, as the lender’s risk increases with a larger loan size.

Types of PMI

There are several types of PMI options, each with its own payment structure. The best option depends on your financial goals, how long you plan to stay in the home, and your current cash flow.

1. Borrower-Paid Mortgage Insurance (BPMI): BPMI is the most common PMI option, where the borrower pays PMI monthly as part of their mortgage payment. Once your loan balance reaches 80% of the home’s original value (or 78% through automatic cancellation), PMI can typically be canceled.
2. Lender-Paid Mortgage Insurance (LPMI): With LPMI, the lender pays the PMI premium for you in exchange for a slightly higher interest rate on your mortgage. While this can reduce your monthly payments, it’s important to note that LPMI cannot be canceled, as the premium is built into the loan’s interest rate.
3. Single-Premium Mortgage Insurance (SPMI): In this type, PMI is paid in a single upfront premium instead of monthly payments. This option can be beneficial if you want to avoid monthly PMI costs and have funds available at closing to cover the premium. SPMI may be financed into the loan amount in some cases, but it generally works best for borrowers who expect to stay in the home long-term.
4. Split-Premium Mortgage Insurance: Split-premium PMI is a hybrid approach where you pay a portion of the PMI upfront at closing and the remainder in monthly installments. This can be a good option if you want to lower your monthly payments without paying the full premium upfront. This approach provides flexibility, especially for borrowers who don’t have a large upfront payment but want manageable monthly PMI costs.

How to Avoid PMI

If you’re looking to avoid PMI altogether, there are a few strategies to consider:

1. Make a 20% Down Payment: The simplest way to avoid PMI is to put down at least 20% of the home’s purchase price. By reaching 20% equity from the start, you can eliminate PMI entirely.
2. Consider a Piggyback Loan (80-10-10 Loan): With a piggyback loan, you put down 10%, take out a primary mortgage for 80% of the home’s value, and use a secondary loan (typically a home equity loan) for the remaining 10%. This allows you to avoid PMI, though it does mean managing two loans.
3. Look into LPMI: As mentioned, some lenders offer lender-paid mortgage insurance where PMI is built into a higher interest rate. This option isn’t for everyone, but it could help you avoid monthly PMI premiums. However, since it cannot be canceled, it works best if you plan to keep the loan for the full term.
4. Request PMI Removal at 20% Equity: Once your loan balance reaches 80% of your home’s original value, you may be eligible to request PMI cancellation. Most lenders are legally required to automatically cancel PMI once you reach 22% equity, but you may be able to eliminate it sooner by initiating the request at 20%.
5. Refinance: If your home has appreciated significantly since you bought it, you may be able to refinance to eliminate PMI. Refinancing is subject to lender approval and will incur closing costs, so it’s worth weighing this option carefully.

Need More Info on PMI?

Private mortgage insurance (PMI) helps homebuyers secure a loan with a smaller down payment, but it’s important to understand how it works and how to manage or avoid it. If you’re looking for guidance on PMI or are ready to start the loan process, contact a Coastline Capital loan officer today. Our team is here to help you explore your options and find the best solution for your mortgage needs.

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