When navigating the world of mortgages, you might come across the term “PMI” and wonder what it stands for and how it applies to you. PMI, or private mortgage insurance, is an extra monthly cost tacked onto your conventional mortgage payment if your down payment is less than 20% of the home’s purchase price.
Why Does PMI Exist?
Think of PMI as a safety net for the lender. With a smaller down payment, there’s a higher risk that you, the borrower, might default on the loan. Private mortgage insurance protects the lender in case you stop making your mortgage payments by covering a portion of the loss if the house goes into foreclosure.
When Does Private Mortgage Insurance Go Away?
The good news is that PMI isn’t permanent. Typically, PMI is automatically cancelled once your loan-to-value (LTV) ratio reaches 80%. Your LTV ratio is the amount you still owe on your mortgage divided by the current value of your home. So, as you make your monthly payments and your home value (hopefully) increases, you’ll reach that 80% mark and PMI will disappear. Some lenders may also allow you to request PMI cancellation once your equity reaches 20% of the original appraised value.
Which Mortgage Types Require PMI?
PMI is generally required for conventional loans (mortgages not insured by the government) where the down payment is less than 20%. However, there are some exceptions.
Government-back Loans
USDA, FHA and VA loans don’t require borrowers to pay PMI, however, FHA loans do have their own mortgage insurance premiums (MIP) that function similarly. The rules for when you need to pay this type of mortgage insurance are different than PMI and the amount you pay can be different as well.
Down Payment Assistance Programs
Some down payment assistance programs may allow you to put down less than 20% while avoiding Private Mortgage Insurance. There are often additional requirements or restrictions with these programs, so be sure to weigh the pros and cons carefully.
PMI can be an extra cost to consider when budgeting for your mortgage, but it allows you to purchase a home sooner even with a smaller down payment. By understanding Private Mortgage Insurance and how it works, you can factor it into your financial plans and make informed decisions about your mortgage options.
