Definition
Private Mortgage Insurance (PMI) is a type of insurance that protects lenders against the risk of loss if a borrower defaults on a conventional mortgage. PMI is typically required when a borrower makes a down payment of less than 20% of the home’s purchase price. Unlike homeowner’s insurance, PMI does not protect the borrower; it safeguards the lender’s investment in case of foreclosure.
Explanation
PMI is usually paid as part of the monthly mortgage payment, but it can also be paid upfront at closing or as a combination of both. The cost of PMI depends on factors such as loan amount, down payment size, and credit score. Once the loan-to-value (LTV) ratio reaches 80% or lower, borrowers can request to cancel PMI. By law, lenders must automatically terminate PMI when the LTV reaches 78% based on the original purchase price or appraised value.
✅ Key Features of PMI:
- Required for Conventional Loans: Not applicable to FHA, VA, or USDA loans, which have their own insurance requirements.
- Variety of Payment Options: Monthly premiums, upfront payments, or a mix of both.
- Cancellation Options: Can be removed when LTV reaches 80% or automatically at 78%.
Pros and Cons of PMI
✅ Advantages:
- Enables Lower Down Payments: Allows buyers to purchase homes with less than 20% down.
- Faster Path to Homeownership: Helps buyers enter the market sooner.
- Cancelable: Can be removed once equity reaches 20%.
❌ Disadvantages:
- Additional Cost: Increases monthly payments without benefiting the borrower directly.
- Non-Tax Deductible: In many cases, PMI payments are not tax-deductible.
- Equity Requirements: Requires significant equity buildup to cancel.
Example
A buyer purchases a home for $300,000 with a 10% down payment of $30,000, resulting in a loan amount of $270,000 and an LTV of 90%. The lender requires PMI until the LTV drops to 80%. The PMI cost is $100 per month, which is added to the monthly mortgage payment. Once the loan balance reaches $240,000 (80% of the home’s value), the borrower can request to cancel PMI.