What Is PMI
Many people who decide to purchase a home are bound to come across the term PMI. Acronym for Private Mortgage Insurance, PMI is meant to protect lenders when borrowers default on their mortgages. Now that you know what PMI does for lenders, let’s focus on its implications for borrowers.
Why Do Some Borrowers Need to Pay PMI?
An important aspect is that not everyone is required to get PMI when taking out a conventional mortgage to purchase a piece of property. If you’re able to put down 20 percent of the property’s value, which is the minimum down payment generally required by conventional lenders, PMI is no longer needed.
Depending on the value of the home, 20% could amount to a lot of money. As an example, a 20-percent down payment on a $200,000 property means $40,000. But what if you cannot afford or choose not to provide the down payment required? In this case, you may still qualify for a home loan, under certain conditions.
In a nutshell, a smaller down payment translates into extra risks for lenders. To minimize these risks, most lenders require PMI in addition to a higher interest rate. However, lenders analyze the application of each potential borrower in order to determine if PMI is required.
Besides the amount of the down payment, credit score, and the type and size of the loan a borrower applies for, lenders factor in the loan-to-value (LTV) ratio. To calculate this ratio, which is expressed as a percentage, they divide the amount of the mortgage by the value of the home, and then multiply the result by 100.
Assuming that you apply for a $180,000 mortgage to purchase a home that’s worth $200,000, the LTV ratio will be 90%. Typically, mortgages that carry LTV ratios above 80% are considered riskier than those with lower ratios. As a result, lenders require PMI in these cases.
Here are a few more things you should know about PMI:
- The PMI premium is generally rolled into the monthly mortgage payment;
- The amount of PMI a borrower needs to pay varies according to the amount of down payment, loan term and credit score;
- PMI isn’t required for VA loans.
How Long Does a Borrower Have to Pay PMI?
Under the federal law, lenders are required to cancel PMI automatically when the LTV ratio hits 78% of the original home’s value. Considering the example above, your lender should cancel the PMI payment when the outstanding principal balance on your $180,000 mortgage drops to $156,000.
There are also a few things you can do to speed up the cancelation of PMI. First, you can increase your monthly payment toward the principal balance of your mortgage. This will allow you to reach the LTV ratio of 78% sooner. Second, if you have made additional payments to reduce the principal balance and the LTV ratio has dropped to 80%, you can contact your lender and ask that the mortgage insurance be removed, according to the Homeowners Protection Act.
Unlike the PMI on conventional mortgages, the mortgage insurance premium on FHA home loans can’t be canceled when the home’s equity reaches 20%. In fact, many borrowers with FHA loans pay mortgage insurance premiums for the life of the loan or until they refinance.
PMI is often seen as a major disadvantage of conventional mortgages. However, it allows people to buy homes with less than 20% down. In addition, PMI premiums can be deducted from federal taxes, provided that certain requirements are met. For the deductibility of PMI, make sure you consult your tax advisor.
Although Whitworth Builders doesn’t offer financing packages, buying a home can be made simple with any of our preferred lenders. For mortgage-related questions, please don’t hesitate to contact them. For purchasing or building a home in a safe, military-friendly and family-oriented community in Northwest Florida, we invite you to visit us in Fort Walton Beach, FL, or get in touch with our friendly and knowledgeable staff by calling (850)-862-6861.