Do I Need Private Mortgage Insurance (PMI)?

Don't worry, we won't give you PMI 'TMI', only what you need to know as a potential homeowner. PMI is the common acronym used in reference to Private Mortgage Insurance. PMI is insurance that is paid by the borrower in order to insure the borrower’s mortgage loan from default. Ideally when you get a loan, you won’t need to pay extra for private mortgage insurance, and the only bills you’ll need to worry about are your mortgage payment, property taxes, homeowner’s insurance, utilities. But in what situations will you be required to pay PMI?

When do I need PMI?

PMI is required for conventional and FHA mortgages with down payments less than 20%. The reason for the PMI requirement is a matter of risk management for the lender in case you default on your loan and there is not sufficient equity in the property for the lender to recover their loaned amount. PMI is paid as a monthly premium similarly to other forms of insurance.

Who Pays PMI?

Generally, if the mortgage is one with a very low down payment, then the borrower will pay the PMI, but there are some loan programs with sub 20% down payments where the lender pays the PMI instead. When it comes to Federal Housing Administration (FHA) loans, the government essentially provides the PMI, and the insurance premium is paid by the borrower and rolled into the monthly mortgage payment.

Why do lenders require PMI?

Imagine someone defaults on their loan with only 3% down, and ownership of the home goes back to the bank. Now, in order to get all their money back, the bank puts the house up for sale, hoping to sell it for at least 97% of what the now defaulted borrower paid for it. By selling it for at least 97% of that amount, the bank then will recoup 100% of money it lost on the default.

Now imagine the housing market falls by 10% during this time. Unlikely, but still possible right? This means that the lender can now only sell the house for 90% of its original value, AT MOST. This means that the lender just lost at least 7% of their money, which can be tens of thousands of dollars. In order to combat this, PMI insures the lender against this home market value risk. There are other scenarios in which PMI helps, but this idea is the basic premise of why the federal underwriting guidelines require PMI on loans with less than 20% equity.

Will I always have to pay PMI?

The good news is no, you do not! Over time as pay your mortgage you gain more equity in your home, and you will eventually get to that 20% equity threshold (Remember that if you put a 20% down payment initially, you would have started with 20% equity). When this happens, you can work with your broker to refinance your loan and change the terms in order to eliminate the PMI payment! There are certain circumstances when a lender must release a borrower from PMI, but the easiest and most certain way to remove PMI is to refinance to a conventional loan with a loan to value at or below 80%.

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