Do Conventional Loans Have Private Mortgage Insurance?

Conventional loans are a common financing option for homebuyers. When securing such a loan, borrowers often encounter Private Mortgage Insurance (PMI). This article clarifies how PMI functions with conventional lending, detailing when it is necessary and outlining strategies for avoiding and removing it.

Understanding Private Mortgage Insurance

Private Mortgage Insurance (PMI) is an insurance policy designed to protect the mortgage lender if a borrower defaults on their loan payments. This protection allows lenders to offer loans to individuals with smaller down payments, mitigating the lender’s risk when the borrower’s equity in the property is limited.

PMI premiums are typically paid by the borrower. The most common method is a monthly premium added to the regular mortgage payment, continuing until the PMI requirement is met or removed. Some lenders may also offer a single, upfront premium, or a combination of an upfront premium and a reduced monthly payment.

When Conventional Loans Require PMI

Conventional loans require Private Mortgage Insurance when the borrower’s down payment is less than 20% of the home’s purchase price, resulting in a loan-to-value (LTV) ratio exceeding 80%. The LTV ratio is calculated by dividing the loan amount by the home’s appraised value or purchase price.

Lenders require PMI because a lower down payment signifies a higher risk of default. Borrowers with less equity may be more likely to walk away from the property if financial difficulties arise. PMI serves as a financial safeguard for the lender against potential losses if the borrower defaults and the property’s sale does not cover the outstanding loan balance.

Strategies to Avoid PMI

One direct way to avoid Private Mortgage Insurance on a conventional loan is to make a down payment of 20% or more of the home’s purchase price. By contributing a larger sum upfront, borrowers establish at least 20% equity, reducing the lender’s risk and eliminating the need for PMI. This approach can also result in a lower loan amount, leading to reduced monthly mortgage payments and less interest paid over the life of the loan.

Another strategy, sometimes referred to as a “piggyback loan,” involves taking out a second mortgage simultaneously with the primary mortgage. A common structure is an 80/10/10 loan: 80% financed by the primary mortgage, 10% from a second loan (often a home equity line of credit or HELOC), and the remaining 10% as the borrower’s down payment. This method allows the borrower to avoid PMI on the primary loan by keeping its LTV at 80% while still making a down payment of less than 20%. However, the second loan will have its own interest rate and repayment terms, which should be carefully considered.

Methods for Removing PMI

Once a conventional loan includes Private Mortgage Insurance, several methods exist for its removal. The Homeowners Protection Act (HPA) of 1998 provides guidelines for automatic termination and borrower-initiated cancellation of PMI.

PMI automatically terminates when the loan’s principal balance reaches 78% of the original value of the home, provided the borrower is current on payments. Lenders are required to notify borrowers annually about their PMI cancellation rights and when their loan balance is projected to reach the 78% threshold. PMI also automatically terminates at the halfway point of the loan’s amortization schedule, provided payments are current.

Borrowers can request PMI cancellation once their loan balance reaches 80% of the home’s original value. To do this, borrowers need a good payment history, meaning no 60-day late payments in the last 24 months and no 30-day late payments in the last 12 months. The lender may require an appraisal to verify the current market value of the home, which the borrower is responsible for covering, with costs typically ranging from $400 to $600. Refinancing the mortgage into a new loan with a loan-to-value ratio of 80% or less can also eliminate PMI, if the new loan meets the lender’s criteria.