All About PMI

Happy Family in Front of Their Home

Private Mortgage Insurance (PMI) is required on all loan transactions where the loan-to-value ratio is 80 percent or greater. (Some cash-out refinance transactions require PMI at 75% loan-to-value.) This means that if you bought your house for $100,000 and had a down payment of less than $20,000, you pay PMI.

PMI insures the lender – not you – against your default on the loan. Because statistics show that borrowers who put down less than 20 percent are more likely to default on the loan, lenders require PMI so that they’ll recoup their investment in case of default. Under normal circumstances, the lender would not make the loan, but they’re willing to take the risk as long as you pay PMI.

HOW DO YOU GET RID OF PMI?

PMI is of concern to the borrower because, unlike mortgage interest, PMI is sometimes not tax deductible.

WHEN CAN YOU STOP PAYING PMI?

The lender cannot force you to keep the PMI once the loan-to-value has gone below 80 percent. However, your phone will not ring the moment you’ve paid the balance below the level requiring PMI. So what you want to do first is to take a look at your most recent mortgage statement and divide the remaining principal balance by the original purchase price of your home. If that number is below 80 percent, call the lender and find out their procedure for removing PMI.

If you haven’t been paying on the loan for very long, you still may qualify for having PMI removed by virtue of appreciation. The lender probably will require a full appraisal, which will cost you approximately $300. But you will quickly recover this cost by not having to pay the PMI. After the cost is recovered, the amount you were spending on PMI goes in your pocket. You can pay a little extra each month toward the principal to reduce your loan balance and shorten the time you must pay PMI.

HOW CAN YOU AVOID PAYING PMI?

There are ways of both avoiding PMI and achieving a smaller than 20 percent down payment. Many lenders offer a loan called an “80/10/10.” Instead of one loan, you get two. You’ll have a first mortgage of 80 percent of the home’s value, a second mortgage of 10 percent of the home’s value, and you’ll make a 10 percent down payment. Some lenders may even offer an 80/15/5. This may seem bizarre, since you’re still borrowing the same amount of money, but the lender in the “first position” is only on the hook for 80 percent, which is less of a risk than a higher amount. You get the small down payment and the tax-deductible interest. In addition, the total monthly payments are often smaller than one larger loan with PMI.

The other way out is to get a loan that builds the PMI into the interest rate. In this case, you agree to pay a higher interest rate in exchange for the lender loaning you more money than they normally would. It can be a nice compromise, because the interest is still tax deductible and it’s simpler than doing two loan transactions. The key here is comparison. Ask your loan agent to run some numbers for you on an 80/10/10 and a loan with built-in PMI. Then see which one will cost less.

Note that these principles apply only to conventional loans. FHA loans have a Mortgage Insurance Premium (MIP), which is required for the life of the loan.5