PMI is known as private mortgage insurance. When you’re buying a home, most lenders require a down payment equal to 20% of the home’s purchase price. If a borrower can’t afford that amount, the lender will most likely view the loan as a riskier investment and require the homebuyer to take out PMI as part of getting a mortgage.
During underwriting, lenders will look at the loan’s LTV (loan-to-value) ratio. LTV is calculated by dividing the amount of the loan by the value of the home. If the LTV ratio is greater than 80%, then the lender will most likely require PMI as the borrower is more likely to default on the loan.
The purpose of PMI is to protect the lender in the event the borrower defaults on the mortgage, and the home goes into foreclosure. PMI does not protect the buyer.
PMI is not inexpensive, costing between .5% and 1% of the mortgage amount annually. The PMI is usually included in the monthly mortgage payment, which also includes taxes, insurance, and other fees as part of the loan.
The good news is that PMI is not permanent and can be removed once the borrower pays down enough of the mortgage’s principal. PMI can also be stopped if the value of the property increases, causing the homeowner to have more equity in the home.
To avoid paying PMI, have a 20% down payment on the loan. If that’s not possible, another option is to piggyback a smaller loan on the principal loan to cover the down payment. The smaller loan is usually at a higher interest rate than a traditional mortgage, but the borrower wouldn’t be paying PMI.
Getting a loan with a PMI isn’t necessarily a bad thing as long as the borrower is comfortable with the expense. However, with your next home purchase, try and find a way to put down at least 20% of the purchase price so you’re not saddled with an unnecessary added expense.