Is PMI Included in Your Escrow Payment?

Homeownership involves various financial components beyond the primary mortgage loan. Among these are private mortgage insurance (PMI) and escrow accounts. This article clarifies PMI and escrow accounts, explaining their functions and interrelation within mortgage payments.

Understanding Private Mortgage Insurance (PMI)

Private Mortgage Insurance (PMI) protects the lender if a homeowner defaults on their mortgage loan. Lenders typically require PMI for conventional mortgages when a borrower makes a down payment of less than 20% of the home’s purchase price. Although the borrower pays the premiums, the benefit accrues directly to the mortgage lender.

The cost of PMI can vary, generally ranging from 0.3% to 1.5% of the original loan amount annually, influenced by factors like the loan-to-value (LTV) ratio, credit score, and loan type. Common types of PMI include borrower-paid monthly premiums, which are the most frequent, and single-premium PMI, paid upfront at closing. Some lenders may also offer lender-paid PMI, where the lender covers the cost in exchange for a higher interest rate on the loan.

Understanding Escrow Accounts

An escrow account, in the context of a mortgage, functions as a third-party account managed by the mortgage servicer. Its primary purpose is to collect and hold funds for specific property-related expenses, such as property taxes and homeowners insurance premiums. This mechanism ensures these bills are paid on time, protecting both the homeowner and the lender’s interest.

Each month, a portion of the homeowner’s mortgage payment is deposited into this escrow account. When property taxes or insurance premiums are due, the mortgage servicer uses the accumulated funds in the escrow account to pay these bills on behalf of the homeowner. This arrangement simplifies financial management for homeowners by breaking down large, infrequent expenses into smaller, more manageable monthly installments.

How PMI and Escrow Connect

In most conventional mortgage scenarios, private mortgage insurance payments are included in the monthly mortgage payment and managed through the escrow account. This consolidation means the homeowner makes one combined payment to their mortgage servicer each month, which covers the principal and interest on the loan, property taxes, homeowners insurance, and PMI. The servicer then allocates these funds, holding the portions for taxes, insurance, and PMI in the escrow account until they are due to be paid to the respective third parties.

This integrated payment approach offers convenience for borrowers by streamlining the financial obligations associated with homeownership into a single transaction. While borrower-paid monthly PMI is typically included in escrow, some alternative payment structures for PMI, such as single-premium PMI paid upfront at closing, would not be part of the ongoing escrow collection.

Removing Private Mortgage Insurance

Homeowners can typically remove PMI once they build sufficient equity in their home. Two primary methods exist for PMI removal, largely governed by the Homeowners Protection Act of 1998 (HPA). The first is borrower-initiated cancellation, which can be requested when the loan-to-value (LTV) ratio reaches 80%, meaning the homeowner has achieved 20% equity based on the original value of the property. To qualify for this, the borrower generally needs a good payment history, typically no 30-day late payments in the past 12 months and no 60-day late payments in the past 24 months, and the property must not have junior liens. An appraisal may be required to confirm the property’s value for this cancellation.

The second method is automatic termination, mandated by the HPA for conventional loans originated after July 29, 1999. PMI is automatically terminated when the LTV ratio reaches 78% of the original loan amount, provided the borrower is current on their mortgage payments. If the borrower is not current on the scheduled termination date, PMI will terminate on the first day of the month after the loan becomes current. Additionally, the HPA stipulates that PMI must be terminated by the midpoint of the loan’s amortization period if it hasn’t been canceled earlier, assuming the borrower is current. Homeowners should contact their mortgage servicer to understand their specific requirements and process for PMI removal.