A Closer Look at How Mortgage Insurance Works 

According to the National Association of REALTORS® the median down payment on a home last year was 12% for all buyers and just 7% for first-time buyers, So, it’s entirely possible to get into a home with less than 20% down. However, anything less than that requires private mortgage insurance (PMI) and many hopeful buyers believe this extra cost may be enough to price them out of homeownership. 

But just how much is mortgage insurance? What are the pros and cons? Let’s explore PMI a bit more and set the record straight. 

What is PMI and how is it calculated? 

The less a borrower puts down on a home, the riskier they appear to a lender. PMI is a form of insurance, paid for by the borrower, which protects the lender against financial loss in the event of foreclosure. 

Wayne Lacy, branch manager with Cherry Creek Mortgage Company in Okemos, says on conventional loans, PMI is calculated using a risk-based pricing model just like any other type of insurance. 

“It’s determined by the risk factors in a loan, which include credit score, down payment amount, debt-to-income ratio, loan amount, and loan purpose, meaning if it’s a purchase or a refinance,” he said. “Generally speaking, rates start around 0.4% of the loan amount and go up from there. It could be as high as 1.2%, or even higher. Again, it just depends on each borrower's financial profile.” 

As an example, Lacy ran some numbers. For a borrower purchasing a home for $225,000 with 5% down, a 760 FICO score, and no major credit events, the monthly premium would be about $46. 

“But if the borrower’s FICO score is lower and/or there are some blemishes on the credit report, the rate could go up,” said Lacy. “For instance, a 1.0% PMI rate on that $225,000 loan would be about $187 a month.” 

How is PMI paid? 

While we most often speak about PMI being paid in a monthly premium, it can also be paid in one lump sum at closing. A borrower can also possibly remove it from the loan by increasing their interest rate to cover the premium. 

Lacy says how PMI is paid is an important consideration, especially in today’s environment. 

“Currently we are closing at such low interest rates that borrowers may want to think about taking a bit higher rate and paying off PMI up front,” he said. “That way they can lock in a low rate and not worry about paying a monthly premium or refinancing two years down the road for a much higher rate, or possibly the same rate, but with closing costs.” 

How long do I pay PMI? 

Your loan amortization schedule lists the date when PMI will be cancelled, which is typically when a borrower reaches 22% equity (78% loan-to-value). 

“You can request to cancel PMI earlier if you’ve made additional payments that reduce the principal balance of your mortgage to 80% loan-to-value,” said Lacy. “But whether or not it’s removed at that time is up to the lender, and they may require an appraisal to prove the value of the property hasn’t declined below the original value of the home.”

 
How does it work with government-backed loans? 

Instead of PMI, government-backed loans require borrowers to pay a mortgage insurance premium, or MIP. 

While PMI is risk-based, MIP is a flat rate based on the loan amount. For example, on FHA loans, borrowers will pay 1.75% of loan amount up front (financed into the loan) and .80% to 1.05% percent annually, depending on the total loan amount. Unlike conventional loans, the MIP is typically required for the life of the loan. 

What are the benefits of PMI?

Of course mortgage insurance is an extra cost and for most homebuyers, any extra cost can seem like a burden. However, PMI can be extremely beneficial, especially when you consider the current market conditions. 

According to NAR, “the median existing-home price for all housing types in September was $352,800, up 13.3% from September 2020 ($311,500).” The Association noted, “This marks 115 straight months of year-over-year increases.” 

While the growth may not be as much as it was this past year, many experts believe home prices will continue to rise in 2022. Those waiting to purchase until they save a higher down payment, could be chasing home prices for a long time. However, PMI lets hopeful buyers purchase at today’s prices and historically low mortgage rates, eliminating the risk of both skyrocketing in the future. 

“There is a negative feeling associated with PMI, but it really shouldn’t scare buyers away,” said Lacy. “There is a range of payment options available, and we’re able to find a variety of ways to bring deals together. I wouldn't want any potential buyer to put off homeownership simply because of fear over PMI. Talk with a local lender, run the numbers, and discuss the options available before you make a decision.” 

For a list of local lenders visit the Greater Lansing Association of REALTORS® website at www.lansing-realestate.com.