Private mortgage insurance, also known as PMI, protects the lender in the event that the borrower defaults on their loan. Borrowers tend to try to avoid PMI because it’s expensive and doesn’t benefit the borrower paying for it. On the other hand, some borrowers simply cannot buy a home without getting private mortgage insurance. PMI applies to outstanding principal when a borrower puts down less than 20%, and generally lasts until the loan-to-value (LTV) ratio falls below 80%. If a borrower tries to calculate private mortgage insurance premiums for their loan, they will soon realize that it is expensive, so they should try to avoid PMI as much as possible. If a borrower already has private mortgage insurance, there are ways for a borrower to stop paying for it.
Private mortgage contracts, like mortgage terms, are fixed and must be renegotiated after the current private mortgage insurance expires. The duration of a private mortgage insurance contract is usually 1 year, but can be up to 6 months and up to 3 years. In general, private mortgage insurance companies offer multiple terms to suit the largest number of borrowers. This flexibility in term length is due to the fact that most mortgage lenders do not require private mortgage insurance as the LTV on the loan reaches 80%, which equates to a 20% down payment.
It is important to note that private mortgage insurance companies may also offer different rates for different terms, even if the borrower’s financial situation does not change. For example, if a borrower has private mortgage insurance for 1 year, they may get a better rate if they have private mortgage insurance for 6 months. In general, mortgage insurance companies prefer to issue long-term insurance because it provides a greater profit for a similar amount of work. A borrower who doesn’t plan to break the 80% LTV ratio on their mortgage anytime soon should opt for long-term private mortgage insurance to save some money down the road. Getting a short-term PMI only applies when a borrower is close to lowering their LTV below 80%. Once the borrower reaches an LTV of less than 80%, their lender may no longer require PMI. This means that the borrower does not have to pay PMI premiums when the LTV is below 80%. For example, if a borrower expects their LTV to be below 80% in 6 months, they may be better off taking out private mortgage insurance for 6 months rather than 1 year.
It is never in a borrower’s best interest to pay PMI premiums because it does not protect them, it protects the lender. Private mortgage insurance can also be very expensive and ranges from 0.5% to 1.5% of the outstanding principal. For example, if a borrower obtains PMI at a rate of 1% on a mortgage with an outstanding principal of $500,000, the borrower will have to pay an additional $5,000 to cover the annual cost of insurance. Although some people can find enough money to make a 20% down payment, many people who cannot cover such a large down payment are required to take out private mortgage insurance which adds to their expenses.
There are several ways to avoid private mortgage insurance in part or even completely over the life of the mortgage, as well as avoid PMI entirely. Depending on the borrower’s situation, they may be eligible for government-backed loans that may not require private mortgage insurance. FHA, USDA and VA loans are different types of mortgages backed by US government agencies. Since they are backed by US government agencies, the lenders who issue these loans consider these loans less risky than conventional loans. In addition, government-backed loans typically do not require private mortgage insurance, but they may still require some type of additional financing.
FHA loans are backed by the Federal Housing Administration and offer favorable terms and rates to qualified borrowers. The FHA loan has its own insurance for borrowers with loans that have an LTV of more than 80%. Unlike private mortgage insurance, mortgage insurance premiums for FHA loans are lower and typically range from 0.45% to 1.05% depending on risk factors, as well as the length of the insurance term and LTV ratio.
USDA loans are supported by the US Department of Agriculture and these loans offer favorable terms and conditions to borrowers who purchase an eligible property in a rural area of the United States. USDA loans do not require any insurance, but all USDA loans have an annual fee of 0.35% of the loan balance. This fee is much lower than mortgage insurance premiums for conventional and even FHA loans, but it is important to note that annual fees are charged on USDA loans throughout their life.
Lastly, VA loans are backed by the Department of Veterans Affairs. VA loans are some of the cheapest loans a borrower can get, but they also have strict eligibility requirements. The most important requirement to qualify for a VA loan is that a borrower must be a veteran or an eligible military member. VA loans also do not require private mortgage insurance, but they do require a one-time financing fee of 1.75% of the loan amount. Although 1.75% is a much larger fee than the mortgage insurance fees charged on other loans, it is important to understand that VA loans require the fee to be paid once rather than annually.