Lessons in Loan Lingo: What's a PMI?
What is a PMI? If you're trying to get qualified for a loan, you've heard those initials (among other mysterious terms of lending lingo) spoken, and most of the time everyone takes for granted that you understand them. But what do they mean, exactly? Put in the most simple terms, PMI stands for private mortgage insurance. From there though, things get more complicated. That insurance doesn’t do much to insure you personally; rather, it ensures that banks will get money back even if you default on your loan. PMIs come into play when the applicant can’t or doesn’t want to pay 20% down. Not all such loans require PMIs, but most conventional ones do.
What does the PMI do?
PMIs serve different purposes:
- A)For the bank: If you fail to pay your mortgage payments and your home goes into foreclosure, the insurance company to whom you have been paying PMI payments pays the bank the difference between 20% and the amount you actually put down. For example, if you put down 10% on your loan and later default, the insurance company pays the bank the other 15% of the purchase price of your home.
- B)For you: Though it’s hard to see how this helps you (since you’re effectively paying to insure the bank), the upside of a PMI is that you can still get your loan, even if you can’t pay 20% down.
How much does the PMI cost?
This varies, because the expense a PMI adds to your mortgage is based on the price of the home and the amount you put down. Logically, the less you put down and the more your house costs, the more your PMI will be monthly. And you can’t skip it: it gets wrapped up into your loan package and becomes part of the monthly mortgage.
The Web offers many calculators for calculating PMIs, but the best ones, like this one from Good Mortgage.com, include the interest rate you locked for your loan, as well as the terms of the loan (so, for example 15 or 30 year fixed). Here I’ve inserted a home price of $400K, with 10% down ($40K) instead of the required 20% ($80K in this case) to avoid the PMI.
You are able to see both the PMI alone and how it adds to the monthly mortgage. What you need to do on your own, however, is figure out how much that PMI will cost you long term. Eventually, the PMI expense could overtake the amount you would have paid if you could've come up with 20% down at the time of your loan’s origination. Of course, many people simply can’t, which is how PMIs came to exist in the first place.
Canceling your PMI
As advised by ZipRealty’s Learning Center, “It is important to note that when you have accumulated 20 percent equity in your home, you will want to check into canceling your PMI to lower your monthly mortgage payment.” Legally, you can cancel your PMI at this point, or once you’ve paid enough principal to cover 22% of your home’s original purchase price. Insurance companies used to keep charging you the PMI fee well past the legal point at which you could cancel. They aren’t supposed to do this anymore, but there are some cases in which they can, legally, neglect to automatically cancel the PMI. And since payments on homes change over time in terms of how much initially goes toward principal and how much goes toward interest, the rate at which you actually achieve the magic PMI-free percentage can be complicated to assess. Make sure you study your records closely, tracking what goes toward paying off what each month. If you can make extra payments, dedicated toward principal only, or if you can afford a 15-year fixed loan, you can get rid of the PMI more quickly.
Do all Loans Require a PMI?
No. First of all, if you can pay 20% down, you won’t be required to pay a PMI. But additionally, certain government sponsored loan products don’t require them either, for instance the VA loan.
As always, with something as complex as funding your mortgage, your best bet is to study, learn, and talk to professionals. Your real estate agent may know lenders who work closely with homebuyers in need of private mortgage insurance, or speak to your local credit union for the information on current local regulations and support.
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Anna Marie Erwert writes from both the renter and new buyer perspective, having (finally) achieved both statuses. She focuses on national real estate trends, specializing in the San Francisco Bay Area and Pacific Northwest. Follow Anna on Twitter: @AnnaMarieErwert.