How Does PMI (Private Mortgage Insurance) Work?
One of the measures of risk that lenders use in underwriting a mortgage is the loan-to-value (LTV) ratio. LTV divides the amount of the loan by the value of the home. Most mortgages with an LTV ratio greater than 80% require that the borrower have PMI.
PMI is usually paid monthly as part of the overall mortgage payment, but sometimes it is paid as a one-time up-front premium at closing. PMI isn’t permanent—it can be dropped once a borrower pays down enough of the mortgage’s principal. Provided a borrower is current on their payments, their lender must terminate PMI on the date the loan balance is scheduled to reach 78% of the original value of the home.
Alternatively, a borrower who has paid enough towards the principal amount of the loan (the equivalent of that 20% down payment) can contact their lender and request that the PMI payment is removed.
PMI can cost between 0.5% and 1% of the entire mortgage loan amount annually, which can raise a mortgage payment by quite a bit. Let’s say, for example, that you had a 1% PMI fee on a $200,000 loan. That fee would add approximately $2,000 a year, or $166 each month, to the cost of your mortgage.
For many people, PMI is crucial to buying a home, especially for first-time buyers who may not have saved up the necessary funds to cover a 20% down payment. Paying for this insurance could be worth it in the long run for buyers eager to own their own homes.
However, for first-time homebuyers, PMI may be worth the extra money for the mortgage—and in tax season, many borrowers can deduct it.