Is PMI Based on Appraised Value or Purchase Price?
Navigate the complexities of Private Mortgage Insurance (PMI), learning how its cost is determined by property value and how you can strategically eliminate it.
Private Mortgage Insurance (PMI) is a common component of homeownership. It represents an additional cost that influences monthly mortgage payments. Understanding how PMI functions, when it is required, and how it is calculated is important for current homeowners and those considering purchasing a home.
Understanding Private Mortgage Insurance
Private Mortgage Insurance (PMI) protects mortgage lenders if a borrower defaults on a conventional loan. Lenders typically require PMI when a homebuyer makes a down payment of less than 20% of the home’s purchase price. This lower down payment presents a higher risk for lenders, and PMI helps mitigate that risk.
PMI enables access to homeownership with a smaller upfront investment. Without it, many might find it challenging to save the traditional 20% down payment. While the borrower pays for PMI, its primary beneficiary is the lender, not the homeowner.
Borrower-paid PMI (BPMI) is the most common type, with premiums typically added to the monthly mortgage payment. Other options include single-premium PMI, paid as a one-time lump sum at closing, and lender-paid PMI (LPMI), where the lender covers the cost but usually charges a higher interest rate. PMI differs from Mortgage Insurance Premium (MIP) for FHA loans, which has different requirements and cancellation rules.
Property Value and PMI Calculation
PMI is based on the property’s value at loan origination. The loan-to-value (LTV) ratio, which dictates if PMI is required, uses the lower of the home’s appraised value or its purchase price. This protects the lender against potential overvaluation.
For example, if a home is purchased for $300,000 but appraises at $290,000, the PMI calculation uses the $290,000 appraised value. The LTV ratio, the loan amount divided by the property’s value, is based on this lower figure. If the home is purchased for $300,000 and appraises for $310,000, the $300,000 purchase price is used for the LTV calculation. This aligns the lender’s risk assessment with the most conservative valuation.
The property’s value at loan origination sets the baseline for the mortgage’s entire life concerning PMI. Future changes in market value do not alter the initial LTV used for establishing PMI. This initial value is also the reference point for PMI cancellation, defining the “original value” against which equity accrual is measured.
Factors Determining PMI Cost
Several factors influence the cost of Private Mortgage Insurance beyond the property’s value at loan origination. The loan amount directly impacts the premium; a larger loan generally results in a higher PMI payment. PMI is typically calculated as an annual percentage of the original loan amount.
A borrower’s credit score significantly determines the PMI rate. Higher credit scores lead to more favorable, lower PMI rates, as borrowers are perceived as lower risk. Conversely, a lower credit score may result in a higher PMI premium due to increased perceived risk. The loan-to-value (LTV) ratio also influences cost; a higher LTV (smaller down payment) typically corresponds to a higher PMI rate.
The loan term and type of loan also contribute to the PMI cost. A longer loan term might carry a different risk profile for the insurer, affecting the premium. While PMI is primarily associated with conventional loans, the loan’s specific structure can influence the rate. An annual premium is calculated by multiplying the loan amount by the determined PMI rate, then divided by twelve for monthly payments.
Methods for Eliminating PMI
Homeowners have several avenues to eliminate Private Mortgage Insurance, offering potential savings on monthly mortgage payments. Automatic termination occurs when the principal balance reaches 78% of the property’s original value. This is mandated by the Homeowners Protection Act (HPA) of 1998, provided the borrower is current on payments. The “original value” is the lesser of the sales price or appraised value at loan origination.
Borrowers can also request PMI cancellation once their loan balance reaches 80% of the original value. This requires the homeowner to be current on payments, have a good payment history, and typically, no junior liens. Lenders may require an appraisal to confirm the property’s current value has not declined. If the property’s value has significantly increased, a new appraisal can show the current LTV is below the 80% threshold, allowing for PMI removal even if the loan balance has not yet reached the 80% mark based on the original value.
Refinancing the mortgage is another option to eliminate PMI. If a homeowner refinances and the new loan-to-value ratio is 80% or less based on the current appraised value, PMI will not be required for the new mortgage. While refinancing involves closing costs, it can be a viable strategy if interest rates are favorable or if the property’s value has appreciated considerably.