Is PMI Required for Conventional Loans?

Private Mortgage Insurance (PMI) is an additional cost many homeowners encounter when securing a conventional mortgage. This insurance serves a specific purpose within the lending landscape, primarily to safeguard the lender against potential financial losses. While it adds to the overall expense of homeownership, PMI also facilitates access to mortgages for a broader range of borrowers. Understanding its function, when it is required, and how it can be removed is essential for navigating the conventional loan process.

Understanding Private Mortgage Insurance

Private Mortgage Insurance (PMI) is a policy designed to protect the mortgage lender, not the borrower, in the event of loan default. If a borrower stops making payments, PMI helps cover a portion of the outstanding loan balance, mitigating the lender’s risk. Although the borrower pays for this insurance, the protection it offers is exclusively for the financial institution extending the loan.

Borrowers typically pay PMI in several ways. The most common method involves monthly premiums added to the regular mortgage payment. Other options can include a single upfront premium paid at closing, or a hybrid approach combining an upfront payment with lower monthly premiums. The cost of PMI varies based on factors such as the loan amount, the borrower’s credit score, and the loan-to-value (LTV) ratio.

When Conventional Loans Require PMI

For conventional home loans, Private Mortgage Insurance is required when the borrower’s down payment is less than 20% of the home’s purchase price. This scenario results in a Loan-to-Value (LTV) ratio exceeding 80%. The LTV ratio is a measure that compares the amount borrowed against the appraised value or purchase price of the property, whichever is lower.

To calculate LTV, the loan amount is divided by the property’s value, then multiplied by 100 to express it as a percentage. This requirement is a standard practice for conventional loans to offset the increased risk lenders undertake when borrowers have less equity in the property.

Methods to Avoid PMI

Several strategies can help borrowers avoid Private Mortgage Insurance when securing a conventional loan. The most direct approach involves making a down payment of 20% or more of the home’s purchase price. A 20% down payment ensures the Loan-to-Value (LTV) ratio is 80% or less, eliminating the need for PMI.

Another option is Lender-Paid Mortgage Insurance (LPMI), where the lender covers the PMI premiums. In exchange, the borrower accepts a slightly higher interest rate for the loan’s entire term. While LPMI can result in lower monthly payments, the increased interest rate often costs more over the life of the loan and generally cannot be canceled without refinancing. Some borrowers also utilize a “piggyback loan” structure, such as an 80/10/10 loan, where a first mortgage covers 80% of the home’s value, a second mortgage covers 10%, and the borrower provides a 10% down payment. This allows the borrower to achieve a 20% equity position without a single large down payment, avoiding PMI.

How to Remove PMI

Once a conventional loan includes Private Mortgage Insurance, two primary methods for its removal are governed by the Homeowners Protection Act (HPA) of 1998. This law provides specific guidelines for both automatic termination and borrower-requested cancellation of PMI.

Automatic termination of PMI occurs when the loan balance reaches 78% of the original value of the mortgaged property, based on the initial amortization schedule. This termination is automatic, provided the borrower is current on their mortgage payments. The original value is defined as the lesser of the sales price or the appraised value at the time of purchase.

Borrowers can request cancellation of PMI earlier, when the loan balance reaches 80% of the home’s original value. To qualify for borrower-requested cancellation, the borrower must submit a written request, maintain a good payment history, and ensure no junior liens (like a second mortgage) are on the property. Lenders may require an appraisal to confirm the property’s value has not declined below its original value. Making additional principal payments can help a borrower reach these 80% or 78% LTV thresholds sooner, accelerating PMI removal.