Almost no one has the cash on hand to buy a house, so whether you’re buying your first home or upgrading for a bigger family, odds are that you will need to take out a mortgage in order to afford your new place. A mortgage is simply a loan from a bank or other lender given specifically for the purpose of helping people buy homes.
However, mortgages are often orders of magnitude larger than other kinds of loans — the average cost of a new home in the United States was $368,500 in May of 2018 — so in addition to checking your credit score, lenders may need some additional reassurance that their investment will be safe. This is where private mortgage insurance (PMI) comes in. PMI gives lenders the confidence that they need to lend large balances to riskier borrowers.
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What Is Mortgage Insurance?
Private mortgage insurance (also called PMI) is an insurance policy against a borrower’s mortgage payments. Should the borrower be unable to meet their payment duties on their mortgage, insurance will take up the bill in order to help the bank or lender recover the lost payment or payments.
How Does Mortgage Insurance Work?
In other kinds of insurance policies, you pay a monthly premium and, in the event of the sort of disaster that the insurance covers, the insurance company will step in to foot all or some of the bill on your behalf. Not so with mortgage insurance. If you start missing mortgage payments or worse, if you default on your mortgage, then your PMI will indeed pay the lender, but not on your behalf. PMI exists as a shield to protect lenders from risky mortgages — PMI will not protect you as a borrower if you’re having trouble with mortgage payments! If you’re a borrowering looking for protection, then you’re interested in mortgage protection insurance.
Who Pays for PMI?
Even though PMI doesn’t exist to protect you as a borrower, you are still the one who is responsible for paying the PMI premium. This is because not everyone who takes out a mortgage is required to get PMI. Borrowers only have to pay for mortgage insurance if they are especially high risk — that could be someone with a bad credit score, an unreliable source of income such as a freelancer, or someone who can’t make a down payment of at least 20 percent of their home’s value. All of these factors may cause a lender to require PMI before they will lend the mortgage.
What Does PMI Cover?
Mortgage insurance covers the lender’s income when they take on a risky borrower. If, for whatever reason, a borrower should be unable to make payments, then PMI will make up the loss to the lender. However, it’s important to remember that PMI will not protect you from default or foreclosure — if you are unable to pay your mortgage, then the bank may still foreclose on your home, even though they have been reimbursed through the PMI policy. PMI exists to protect lenders, but it does not absolve borrowers of the responsibilities and risks that come with taking on a mortgage — nor from the negative consequences of default.
Mortgage Insurance vs Home Insurance: What’s the Difference?
Unlike mortgage insurance, home insurance does work to protect the homeowner. Similar to PMI, home insurance can also be required by mortgage lenders, but not for the same reasons. Whereas PMI protects lenders from risky borrowers, home insurance protects homeowners from damage to their home. This is important to lenders because, even if the home is badly damaged or destroyed, the borrower is still required to pay off the mortgage. Home insurance can protect you as a homeowner from penalties in the event of a disaster by covering the cost of the home with the lender. Unlike PMI, home insurance will take you off the hook when it comes to mortgage responsibilities and penalties.
Mortgage Insurance Premium
Like all forms of insurance, PMI requires that you pay a regular premium. A premium is an amount of money that anyone with an insurance policy pays. All of the premiums go into one big pot that helps pay for the administrative costs of running an insurance company and, if an event covered by the policy should happen, the payout also comes from that big pot.
PMI Rates: What Does Mortgage Insurance Cost?
The amount that you will pay for PMI depends on a few things:
- Your credit score. A high credit score means that you are a less risky borrower, so it will cost less to protect against the possibility that you may default on your mortgage.
- The cost of your home. The more expensive your home, the higher you can expect your mortgage insurance premium to be. This is because more expensive homes will require a larger payment from the PMI company in the event that you default on your mortgage.
- The size of your down payment. If you make a downpayment worth 20 percent of your home’s value or more, then you can be off the hook completely for PMI, meaning that you will have a PMI premium of $0.
Do I Need Mortgage Insurance?
Whether or not you need mortgage insurance is up to your lender. Since lenders are the ones who benefit from PMI, they will decide whether or not to require a policy on your mortgage before lending to you.
When PMI Is Required
There are several situations where you will need a PMI policy:
- You are a risky borrower for a conventional mortgage. If you are a risky borrower for whatever reasons — low credit score, unreliable employment, or small down payment — then the lender may require that you have PMI before lending to you.
- If you have a Federal Housing Administration (FHA) loan. PMI insurance is required for all FHA mortgages, although premiums are paid directly to the FHA rather than to a third party PMI insurance company.
- If you have a Department of Agriculture (USDA) loan. Similar to FHA loans, USDA loans also require that borrowers have a PMI policy.
- If you have a home loan from Veterans’ Affairs (VA). In order to help veterans and servicemembers, VA home loans come with a guarantee against default that acts just like a PMI policy. If you have a VA home loan, you will be required to pay a funding fee when you take out the mortgage, but you will not be held responsible for paying a monthly premium.
When Does PMI Go Away?
Unlike other forms of insurance, you don’t always have a say in when your PMI policy is cancelled. All PMI policies end when your house is paid down, so you can get out of your PMI more quickly by paying off your mortgage early. Once your loan balance equal to or less than 78 percent of the original value of the home, your lender is required by law to cancel the PMI policy on your insurance. In some cases, it may also be possible to cancel your PMI by proving yourself to be a good borrower — that means repairing your credit score and showing that you can make on-time payments consistently over several years.
The most important thing to remember about PMI is that it does not exist to protect borrowers. Even though you will have to foot the bill for your mortgage insurance policy, you will not be relieved from your duties as a mortgage borrower if coverage should kick in for any reason.
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