When Is PMI Insurance Required on a Mortgage?

Private Mortgage Insurance (PMI) protects the lender, not the homeowner, if a borrower defaults on their loan. This insurance reduces financial risk for lenders, particularly when a homebuyer makes a smaller down payment. While it adds to monthly housing costs, PMI enables individuals to qualify for a conventional mortgage sooner. It facilitates homeownership for a broader range of buyers.

Circumstances Requiring PMI

Private Mortgage Insurance is required for conventional loans when the borrower’s initial equity in the home is less than 20% of its purchase price or appraised value. This results in a loan-to-value (LTV) ratio exceeding 80%. The LTV ratio is calculated by dividing the loan amount by the home’s appraised value or purchase price, whichever is less. For instance, a $200,000 loan on a home valued at $250,000 would result in an 80% LTV.

Lenders consider loans with LTVs above 80% to carry increased risk because the borrower has less equity in the property. PMI mitigates this risk for the lender by providing a financial safeguard if the borrower defaults, particularly in the early years of the mortgage. Conventional loans with less than a 20% down payment require PMI. Government-backed loans, such as FHA loans, have their own mortgage insurance requirements that differ from PMI.

Calculating PMI Costs

The cost of Private Mortgage Insurance is not fixed and varies based on several factors. Key determinants include the borrower’s loan-to-value (LTV) ratio, credit score, total loan amount, and loan term. A higher LTV ratio or a lower credit score indicates greater risk to the lender, typically resulting in a higher PMI premium. Borrowers with higher credit scores may qualify for lower PMI rates.

PMI rates typically range from 0.2% to 2% of the original loan amount annually. For example, a $300,000 loan with an annual PMI rate of 0.85% would incur an annual cost of $2,550, or about $212.50 per month.

There are several ways borrowers can pay PMI, each affecting their upfront costs and monthly payments. Borrower-paid monthly PMI (BPMI) is the most common arrangement, where the PMI premium is added to the borrower’s regular monthly mortgage payment. Another option is lender-paid PMI (LPMI), where the lender covers the PMI costs, but in exchange for a slightly higher interest rate on the mortgage loan.

A third method is single-premium PMI, which involves paying the entire PMI cost as a one-time, upfront lump sum at closing. This upfront payment can be substantial, but it eliminates ongoing monthly PMI payments. Some lenders may also offer a split-premium option, combining a smaller upfront payment with reduced monthly premiums.

Methods for Removing PMI

Homeowners can remove Private Mortgage Insurance through specific processes, primarily governed by the Homeowners Protection Act (HPA) of 1998. This federal law established clear guidelines for both automatic termination and borrower-initiated cancellation of PMI on conventional loans. The HPA applies to privately insured first mortgages on single-family primary residences that closed on or after July 29, 1999.

Automatic termination of PMI occurs when the principal balance of the mortgage is scheduled to reach 78% of the home’s original value. This termination is mandatory by the lender, provided the borrower is current on payments. The “original value” is defined as the lesser of the property’s sale price or its appraised value at the time the mortgage was created. Even if the property’s market value declines, automatic termination must occur at the 78% LTV threshold based on the original value.

Borrowers can also proactively request PMI cancellation once their principal balance reaches 80% of the original value of the home. To initiate this, the borrower needs to submit a written request to their loan servicer. Requirements for borrower-initiated cancellation include a good payment history, meaning no 30-day late payments in the past 12 months and no 60-day late payments in the past 24 months.

Lenders may also require an appraisal to confirm the home’s current value has not fallen below the original value, ensuring sufficient equity remains. If PMI is terminated or canceled, servicers are required to refund any unearned premiums to the borrower within 45 days. Refinancing the mortgage loan to a new loan without PMI is another method, often pursued if the home’s value has significantly appreciated or if the borrower has accumulated substantial equity.