When Do You Need Private Mortgage Insurance (PMI)?
Understand when private mortgage insurance (PMI) is required, how to proactively avoid it, and effective ways to remove it from your mortgage.
Private Mortgage Insurance (PMI) serves as a financial safeguard for mortgage lenders, protecting them if a borrower defaults. Although borrowers pay the premiums, PMI directly benefits the lender by mitigating risk associated with smaller down payments. Its requirement is typically tied to the borrower’s equity at loan origination.
Understanding When PMI is Required
Private Mortgage Insurance is primarily required for conventional mortgage loans when a borrower’s down payment is less than 20% of the home’s purchase price. This requirement stems from the loan-to-value (LTV) ratio, which compares the loan amount to the home’s value. For instance, if a home is purchased for $300,000 and the borrower puts down $30,000 (10%), the LTV ratio would be 90%, triggering PMI.
Lenders consider loans with an LTV ratio exceeding 80% higher risk, which PMI helps offset. While the 20% down payment rule is the most common trigger for PMI on conventional loans, it can also be required in certain refinance situations if the borrower’s equity falls below 20%. The cost of PMI typically ranges from 0.30% to 1.5% of the loan amount annually, influenced by factors such as credit score, LTV ratio, and loan type.
Approaches to Avoiding PMI
Borrowers have several strategies to avoid paying Private Mortgage Insurance. The most direct method involves making a down payment of 20% or more of the home’s purchase price. A larger down payment immediately reduces the loan-to-value (LTV) ratio to 80% or below, eliminating PMI. This approach can also result in a lower overall loan amount and potentially more favorable interest rates.
Another strategy is a “piggyback” loan, often structured as an 80/10/10 loan. In this arrangement, the borrower takes out a first mortgage for 80% of the home’s value, a second mortgage for 10% of the value, and provides a 10% cash down payment. This structure allows the borrower to achieve an effective 20% equity position, bypassing PMI. While the second loan adds another debt obligation, it can be a viable alternative for those who have sufficient income but limited liquid cash for a large down payment.
Lender-Paid Mortgage Insurance (LPMI) offers another way to avoid a separate monthly PMI premium. With LPMI, the lender pays the mortgage insurance cost, but they typically recoup this expense by charging a slightly higher interest rate on the primary mortgage loan. Although LPMI means no distinct PMI line item on the monthly statement, the borrower indirectly pays for it through increased interest over the life of the loan. Unlike traditional PMI, LPMI is usually not cancellable once the loan is established, meaning the higher interest rate persists unless the loan is refinanced.
Removing PMI From Your Loan
Once Private Mortgage Insurance is established, there are specific pathways for its discontinuation. The Homeowners Protection Act (HPA) provides federal guidelines for PMI termination on conventional loans. Under the HPA, PMI must automatically terminate when the principal balance of the mortgage reaches 78% of the original value of the home, based on the initial amortization schedule. Automatic termination also occurs when the loan reaches its midpoint (e.g., 15 years into a 30-year mortgage), whichever comes first, provided the borrower is current on payments.
Borrowers can also proactively request PMI cancellation once their loan balance reaches 80% of the home’s original value. To initiate this process, the borrower typically needs to contact their mortgage servicer in writing and demonstrate a good payment history, generally meaning no payments 30 days late in the past 12 months and no 60-day late payments in the previous 24 months. The “original value” is usually defined as the lesser of the contract sales price or the appraised value at the time of purchase.
In situations where the home’s value has appreciated significantly since purchase, or substantial improvements have been made, a borrower might be able to request cancellation earlier. This often involves obtaining a new appraisal to confirm the current higher value, which the borrower typically pays for. If the new appraisal shows the loan-to-value ratio is 80% or lower based on the current market value, and other conditions like a good payment history are met, the servicer may agree to cancel PMI.