Private Mortgage Insurance (PMI) is a type of insurance that lenders typically require from borrowers who make a down payment of less than 20% on a home purchase. PMI protects the lender in case the borrower defaults on the mortgage loan.
Here’s how PMI works:
- Lender Protection: PMI protects the lender by providing coverage for a portion of the outstanding loan balance if the borrower defaults on the mortgage and the lender forecloses on the property. This insurance helps mitigate the lender’s risk of financial loss in cases where the borrower has insufficient equity in the home.
- Borrower Responsibility: While PMI benefits the lender, the borrower is responsible for paying the premiums. PMI premiums are typically added to the borrower’s monthly mortgage payments, increasing the total monthly housing expenses.
- Cancellation: In many cases, PMI can be canceled once the borrower reaches a certain level of equity in the home, usually when the loan-to-value (LTV) ratio falls below 80%. This can occur through a combination of regular mortgage payments and appreciation in the home’s value over time. Borrowers may need to request PMI cancellation from their lender once they meet the requirements.
- Cost: The cost of PMI can vary depending on factors such as the size of the down payment, the loan amount, the borrower’s credit score, and the type of mortgage loan. PMI premiums typically range from 0.5% to 1% of the loan amount annually.
- Types of PMI: There are different types of PMI arrangements, including borrower-paid PMI, lender-paid PMI, and single-premium PMI. Borrower-paid PMI is the most common type, where the borrower pays the premiums as part of their monthly mortgage payments. Lender-paid PMI involves the lender paying the premiums upfront in exchange for a higher interest rate on the loan. Single-premium PMI involves paying the entire premium upfront at closing.
PMI is a common feature of many mortgage loans, particularly for borrowers who are unable to make a 20% down payment. While it adds to the cost of homeownership, PMI allows borrowers to qualify for a mortgage with a smaller down payment and can help make homeownership more accessible to a broader range of individuals and families.