When is private mortgage insurance required?

Owning a home is a wonderful experience but purchasing a home can sometimes be stressful. Don’t worry though! We're here to help because purchasing a home should be just as great as owning a home.

You may have many questions when picking out a lender and a mortgage. Among those questions is probably: what is private mortgage insurance and do I need it? Here is what you need to know.

What is private mortgage insurance and when will it be required?

Private mortgage insurance or PMI is a type of mortgage insurance that protects the lender if you stop making payments on your home loan. It creates less risk for the lender because it ensures that they will get paid if you default on your loan or if you are unable to pay your mortgage. It’s required by some mortgage lenders if you don’t put 20 percent down on a home purchase in a conventional mortgage.

There are two types of mortgage insurance: government and private. The government insurer is called the Federal Housing Administration. We will be discussing private mortgage insurance. Mortgage insurance is different than homeowners insurance.

How long do you pay mortgage insurance and how do I cancel it?

There isn’t an exact number to this question because a lot depends on the type of private mortgage insurance you have. Each type requires that you have paid 22 percent of the home’s purchase price before your PMI is canceled. This loan balance number is calculated using the mortgage’s loan to value (LTV) ratio.

There are three types of private mortgage insurance:

• Borrower-paid PMI means you pay a premium each month until your PMI is terminated or when it is canceled at your request in writing. You need to have paid 22 percent of the purchase price of your home before the PMI is canceled or you can request it to be terminated.
• Single Premium PMI means you pay the insurance premium up front in full. This removes the need for monthly payments.
• Lender-paid MI means your mortgage insurance is lumped into your mortgage interest rate for the life of your loan. The rate is higher because the cost of the MI is included. (Alliant receives a discount on LPMI products because they are a credit union. They pass their savings onto their members so when they save, you save. Alliant’s LPMI is cheaper than many MI programs.)

When calculating how long you will need PMI, take a look at how long it will take for you to reach 22 percent equity and the type of mortgage insurance you will be using. In short, read the fine print so you know your options.

How much does private mortgage insurance cost?

PMI fees vary depending on the size of the loan and how much you are putting down. You will typically see that the lower your down payment, the higher your PMI rate. Private mortgage insurance can cost between 0.25 percent and 2 percent of the entire loan on an annual basis.

Let’s break this down: Say your loan is for $200,000. One percent of that loan is $2,000 a year. Your monthly PMI payment will be $166.66. If it takes you five years for you to reach 22 percent, then you will pay $10,000 toward your PMI.

You will not see your equity grow by paying this insurance. You are giving your money away and will not see any return on those dollars. Your private mortgage insurance payments are rolled into your monthly mortgage payments.

Do I need PMI and how do I avoid it?

There are two reasons why you may be required to get private mortgage insurance. The first reason depends on your lender. The second depends on how much you put down.

Many lenders require PMI if you put less than 20 percent down because the loan is viewed as a bigger risk. With a low down payment/higher loan amount, you may also have a higher interest rate. However, other lenders have programs that do not require PMI if you put less than 20 percent down on non-conventional loans.

For example, the Alliant Advantage Mortgage (AAM) program allows first-time homebuyers to put down 0 percent with no PMI payments. The same program also enables non-first-time homebuyers to buy a new home with 5 percent down with no PMI.

The moral of the story: when comparing mortgage lenders, check to see if they require private mortgage insurance if you haven’t saved for a big down payment.

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Katie Levene is a marketer fascinated with finance. Whether the topic is about the psychology of money, investment strategies or simply how to spend better, Katie enjoys diving in and sharing all the details with family, friends and Money Mentor readers. Money management needs to be simplified and Katie hopes she accomplishes that for our readers. The saying goes, "Knowledge is Power", and she hopes you feel empowered after reading Money Mentor.