Are you paying for private mortgage insurance? You may have seen this listed in your monthly mortgage statement, along with the principal, interest and escrow, and wonder what it is and why it's there.
Basically, it's an insurance policy on your mortgage — one that protects the lender rather than you in the event of a loan default. Typically, lenders require private mortgage insurance (PMI) when borrowers meet these two conditions:
- Taking on conventional mortgages (not government backed)
- The down payment is less than 20% of the home’s sale price/valuation.
For example, as of July 2023, the median sale price of a home in Minnesota is $342,995. If your down payment were less than $68,599 on a home at that price, you would likely pay a monthly PMI premium. However, if your down payment were greater than $68,599, it’s likely that you would not pay the monthly PMI premium.
Why do lenders require private mortgage insurance?
You may ask why lenders require PMI. If the borrower defaults, they can recover the loan by simply selling the property, right?
Well, there are various expenses associated with selling properties that enter foreclosure — including maintenance. Unless the property gains value after the original mortgage to help offset those costs, the bank can easily end up taking a loss on a foreclosure. However, when borrowers come up with a 20% or greater down payment, that reduces the risk to the lender. Otherwise, they require PMI to cover the potential gap.
Paying private mortgage insurance is very common, especially for first-time borrowers. In Minnesota, 70% of home purchase loans in 2020 included PMI.1 Financially speaking, not everyone can — or should — wait until they have 20% saved before buying their first home. If you find a great home within your price range, waiting to save 20% can be costlier in the long run. Particularly if home values rise by a significant amount by the time you’re finished saving.
How much is private mortgage insurance?
Forecasting your monthly PMI cost can be tricky to nail down. But the good news is how much you pay is somewhat within your control.
For most borrowers, the cost of PMI is based on a percentage of their mortgage loan. If you’re hoping to pay less on PMI, focusing on these two factors can result in a lower percentage — and a lower monthly mortgage payment:
- Higher down payment to get your loan-to-value ratio as close to 80% as possible.
- Good credit hygiene: Focus on on-time regular monthly payments and other good habits.
As these factors indicate, borrowers viewed as lower-risk (as in less likely to default) may end up paying a lower PMI premium than a high-risk borrower.
Is there a way to get out of paying private mortgage insurance (PMI)?
Here’s some good news about private mortgage insurance: You won’t be stuck with it forever. Eventually, it goes away, thanks to a federal law. But if you’d like to make that expense disappear sooner, we have a few strategies.
First and foremost, if you’re motivated to be done with PMI sooner rather than later, know this number: Your mortgage’s loan-to-value ratio, or your LTV. Once it dips to 80% and lower, most lenders are willing to cancel private mortgage insurance.
Loan-to-value 101: What is it?
Remember the down payment we talked about earlier? When you first take out a mortgage, your LTV ratio is the inverse of your down payment. In other words, if you put down 5% on your house, then your loan-to-value ratio starts off at 95%. Lenders view loans with an LTV ratio of 80% as lower risk.
As time progresses, with each monthly payment you make, this LTV ratio diminishes. The principal portion reduces the outstanding balance on your mortgage. Once you’ve paid enough principal to reach the 80% threshold, you can ask the lender to cancel your private mortgage insurance.
Calculating your LTV ratio is simple: Divide your mortgage balance against the sale price of your property. If you bought your home for $300,000, you’ll reach 80% LTV through the combined effect of your down payment and your principal payments, which would amount to $60,000.
How to cancel private mortgage insurance
Now that you understand the role LTV plays in private mortgage insurance, here are some pathways to eliminating private mortgage insurance from your monthly mortgage statement.
Automatic cancellation: Thanks to the PMI Cancellation Act passed by Congress in 1998, lenders must cancel your PMI payment when your loan-to-value ratio dips to 78%. Otherwise, it goes away halfway into your amortization schedule. In other words, if you have a 30-year mortgage, you typically wouldn't pay PMI any longer than 15 years.
Request cancellation: When your loan-to-value reaches 80%, you can call your lender and ask them to cancel your private mortgage insurance.
Pay extra principal: A surefire way to get out of paying private mortgage insurance earlier is through making additional principal payments. Make biweekly payments, round up your payment to the nearest $50 or $100 or commit to making one, two or even three extra payments a year. Any of these will move the needle.
Refinance: If you can take advantage of a lower interest rate through refinancing, you might also benefit from any increase in the value of your property since your original mortgage. The lender will factor in the current estimated selling price of your home when calculating loan to value. With any luck, your equity combined with higher property values will push your LTV to 80% or lower.
You’re no longer paying for private mortgage insurance — now what?
So you’re no longer paying private mortgage insurance, either because you’re halfway through your payment schedule or you’ve reached 80% loan-to-value on your loan. What can you do with that extra cash? We’d argue for building your financial security. You weren’t using it to pay other expenses before, so you aren’t likely to miss it now!
Once you’re released from private mortgage insurance, these are our top money-wise strategies to channel your freed-up funds:
- Pay ahead on credit card debt and other loans.
- Build your cash savings so you have 3-6 months of reserves.
- Make extra contributions to your health savings account, retirement fund or your child’s 529 plan for college.
- Extra mortgage payments. Use our calculator to discover how much the extra payment can save you in interest.
Minnwest Bank is here to help you grow
Minnwest Bank is here to empower you with knowledge to make informed decisions about your mortgage journey. Choose Minnwest Bank as your mortgage lender, and you’ll gain a team that’s always in your corner. We take time to get to know you, your family and your financial goals, so we can provide the expert guidance to help you achieve your dream of owning a home. And through the life of the loan, help is always a phone call or visit away.
- Mortgage Insurance Data at a Glance | The Urban Institute