PMI stands for Private Mortgage Insurance. It is a type of insurance that lenders typically require borrowers to obtain when they take out a conventional mortgage loan with a down payment of less than 20% of the home's purchase price.
The purpose of PMI is to protect the lender in case the borrower defaults on the mortgage and the home goes into foreclosure. If the borrower has less than 20% equity in the property, the lender views the loan as riskier, and PMI provides an additional layer of protection for the lender.
Here's how PMI works:
1. Cost of PMI: The cost of PMI can vary but is usually based on a percentage of the loan amount. It typically ranges from 0.3% to 1.5% of the original loan amount annually, divided into monthly payments.
2. Added to Monthly Mortgage Payments: Most borrowers who have PMI pay it as part of their monthly mortgage payments. The PMI premium is added to the principal, interest, property taxes, and homeowner's insurance as an additional cost.
3. Automatic Termination: Under the Homeowners Protection Act (HPA) of 1998, lenders are required to automatically terminate PMI when the borrower's equity in the home reaches 22% based on the original property value. Borrowers can also request PMI cancellation when their equity reaches 20%, though some lenders may have additional requirements.
4. PMI for Government-Backed Loans: For loans insured or guaranteed by government entities like the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA), similar insurance is required, known as Mortgage Insurance Premium (MIP) for FHA loans and Funding Fee for VA loans.
PMI enables many homebuyers who cannot afford a 20% down payment to enter the housing market and purchase a home. However, it is an additional cost to consider when budgeting for a mortgage, so borrowers should be aware of how PMI impacts their monthly payments and overall homeownership expenses. Once a borrower has sufficient equity in their home or meets the HPA requirements, they can request PMI removal, which can lead to a reduction in monthly payments.