When Does a Conventional Loan Have PMI?

A conventional loan is a mortgage option not insured or guaranteed by a government entity, distinguishing it from programs like FHA or VA loans. These loans are originated and backed by private lenders. They often adhere to guidelines set by government-sponsored enterprises like Fannie Mae and Freddie Mac.

Understanding Private Mortgage Insurance

Private Mortgage Insurance (PMI) is a type of insurance associated with conventional home loans, primarily protecting the mortgage lender against financial loss if a borrower defaults on their loan payments. While the borrower pays for PMI, the protection benefits the lender, particularly with smaller down payments. This insurance helps mitigate the increased risk lenders undertake with loans that have a higher loan-to-value (LTV) ratio. PMI is an additional monthly expense, separate from homeowners insurance. PMI costs generally range from 0.5% to 1.5% of the original loan amount annually, varying based on factors like credit score and LTV.

When PMI Applies to Conventional Loans

Private Mortgage Insurance is generally required for conventional loans when the borrower’s down payment is less than 20% of the home’s purchase price. This means the loan-to-value (LTV) ratio, which compares the loan amount to the home’s value, is greater than 80%. Lenders impose this requirement because a smaller down payment indicates a higher risk of default. If the down payment is 20% or more, PMI is usually not required, as the lower LTV signifies less risk for the lender. This threshold applies to both new home purchases and refinance loans where the LTV exceeds 80%.

Strategies to Avoid PMI

Borrowers can avoid paying Private Mortgage Insurance from the outset. The most direct method involves making a down payment of 20% or more of the home’s purchase price. This larger upfront investment immediately reduces the loan-to-value ratio to 80% or less, which eliminates the lender’s requirement for PMI.

Another strategy to consider is a “piggyback” loan, often structured as an 80/10/10 or 80/15/5 arrangement. In an 80/10/10 scenario, the first mortgage covers 80% of the home’s value, a second loan covers 10%, and the borrower provides a 10% down payment. This method allows borrowers to avoid PMI while still putting down less than 20% of their own cash. However, this approach involves managing two separate loan payments, and the second loan may carry a higher interest rate than the primary mortgage.

Canceling Private Mortgage Insurance

Once Private Mortgage Insurance is attached to a conventional loan, there are specific conditions and procedures for its removal. The Homeowners Protection Act mandates that lenders automatically terminate PMI when the loan balance is scheduled to reach 78% of the home’s original value. This automatic cancellation occurs provided the borrower is current on their mortgage payments.

Borrowers can also request cancellation of PMI earlier, typically when the loan balance reaches 80% of the original value of the home. To initiate this, the borrower must submit a written request to their loan servicer and maintain a good payment history with no junior liens on the property. The lender may also require an appraisal to confirm the property’s value has not declined below its original value. Additionally, refinancing the mortgage into a new loan with an LTV of 80% or less can also eliminate PMI, assuming the new loan meets the necessary equity requirements.