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Understanding PMI

Understanding PMI and How to Eliminate It

Understanding PMI and the effects that it has on both your closing costs and ongoing monthly payment is crucial when shopping mortgage loans.

Breaking Down Your Mortgage Payment

When you examine your monthly mortgage payment, you will find that it includes several components, with a significant portion allocated to the principal—the dollar value of the money you borrowed. You’ll also find amounts for loan interest and your escrow account, which covers homeowners insurance, property taxes, and in most cases, mortgage insurance. Understanding PMI is crucial when potentially shopping mortgage loans.

For certain mortgages, depending on your down payment and mortgage type, you might notice an additional fee called private mortgage insurance (PMI), which varies based on your loan balance and loan-to-value ratio.

Shedding Light on PMI

Private Mortgage Insurance, or PMI, is a form of insurance designed to protect your lender in case you default on your mortgage. It’s an added expense included in your mortgage payment, and you’re responsible for its monthly premiums.

Lenders gauge risk based on factors like your credit score, repayment history, and the loan amount. A crucial factor is the percentage of the home purchase you’re financing. For instance, financing 90% of the home increases the lender’s risk compared to financing 80%. PMI is mandatory if you finance more than 80% of your home’s appraised value but is not required if your down payment is 20% or more.

Fortunately, there are ways to remove PMI from your mortgage. These include making payments until it automatically cancels, requesting removal when equity reaches 20% or higher, making a significant principal reduction, or getting a new appraisal if your home’s value has increased. However, these strategies mainly apply to conventional loans.

PMI Differences Across Loan Types

Conventional Loan: PMI is straightforward. If you finance over 80% of your home’s value, you need PMI. It automatically drops off when your loan amount hits 78% of the home’s appraised value. Early removal is possible by request upon reaching the 80% equity mark.

FHA Loan: Known as Mortgage Insurance Premium (MIP), it’s similar to PMI but doesn’t drop off automatically unless specific conditions are met. Removal is possible through refinancing into a conventional loan with at least 20% equity.

VA Loan: VA loans, available to U.S. Military members, are exempt from PMI regardless of the financed home value percentage. Borrowers pay a one-time fee, known as the VA funding fee, which sustains the program for future generations.

USDA Loan: These loans, designed for properties in rural areas, waive Private Mortgage Insurance (PMI) but incorporate an annual guarantee fee, often termed a funding fee. This fee includes two parts: an upfront guarantee fee, which is 1% of the loan value, and an annual fee, 0.35% of the loan balance, incorporated into the monthly payment.

Calculating PMI

Your PMI amount depends on factors like your debt-to-income ratio, credit score, home value, and down payment amount. Annual PMI costs range from 0.1% to 2% of the total loan amount, with the exact payment varying within this range.

PMI Removal Without Refinancing

So how do you remove PMI from your mortgage without refinancing? For FHA loans, refinancing is the only option to remove mortgage insurance. Those with conventional loans benefit from automatic PMI elimination when the mortgage balance reaches 78% of the home’s original value or through a professional appraisal showing at least 20% equity.

For more information on home loans and refinancing services, contact your favorite mortgage lender, or if you do not have one, reach out to one of our partners.

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