Mortgage loans come in all shapes and sizes. That’s a good thing for potential homebuyers. It allows you to get into the house of your dreams using flexible terms. In some cases, private mortgage insurance can help make your dream home possible.
What is private mortgage insurance? Think of private mortgage insurance, or PMI, as a protection policy for the lender. It allows the borrower to buy a house with a lower down payment while protecting the lender at the same time.
If you’re house hunting and in the market for a new mortgage, learning all you can about the process will help you make an informed decision about which mortgage to sign up for. The perfect mortgage may be as close as your credit union.
How Private Mortgage Insurance Works
When lenders look at a potential borrower, they use a step-by-step verification process to determine the likelihood that the borrower will repay the entire loan. One of the measures is the loan’s loan-to-value ratio, also referred to as the LTV ratio.
This LTV ratio is the loan amount requested to the value of the purchased home. Lenders use 80 percent as a guideline. Loans are considered high risk if the LTV ratio exceeds 80 percent.
Lenders want a larger safety net for protection, so private mortgage insurance is often the first answer. Private mortgage insurance is paid in several ways:
Monthly
The most common way of paying PMI premiums is with your monthly loan payment. Your monthly loan payment will include PITI—principal, interest, taxes, and insurance. Additionally, your payment will include any mortgage insurance premiums and homeowner’s association fees, as applicable.
UpFront Payments
Another option is to pay the entire yearly PMI payment upfront. Paying upfront will lower your monthly mortgage payment, but you will need to be prepared for a more considerable annual expense until the PMI is paid off.
Hybrid
Another option is a hybrid of the two. You can pay some of the PMI insurance fees upfront and incorporate the rest into each monthly payment. This option can help if you have extra cash to apply and want your monthly payments to stay low.
How PMI Is Removed From Your Monthly Payment
PMI isn’t a permanent part of your monthly payment. It’s a protection policy designed to provide coverage until you reach the 80 percent LTV ratio. Once you, the borrower, pay down enough of your mortgage’s principal, and the LTV ratio falls below 80 percent, you can terminate the PMI.
If you’re paying for PMI, once you’ve reached 20 percent equity, you can contact your loan servicer and request to remove PMI from your monthly payment. By law, lenders must terminate PMI when your LTV ratio is scheduled to reach 78 percent. PMI will automatically drop off conventional loans once the loan balance reaches 78 percent of the appraised value. Automated PMI removal is known as “automatic cancellation.” By law, the mortgage lender will stop PMI withdrawal at no cost to you.
If your home’s value significantly rises before you reach the 80 percent LTV, you can schedule a new home appraisal to prove your home is worth more than the original loan amount. You’ll have to request cancellation in writing in this case.
Is PMI A Bad THing?
Many homeowners view PMI as just one more fee tacked on to the loan amount. While that’s true, PMI isn’t always a bad thing.
Without private mortgage insurance, you would likely pay a higher interest rate. Because lenders take a more significant risk loaning money for a property without much equity, this private mortgage insurance covers their risk. Lenders are willing to give you reasonable rates because this assures them of payment if you default on the loan.
If you use PMI to get into a home, you can always work to pay the balance down faster, so you reach the 80 percent threshold sooner. Then you can cancel the PMI as you continue paying off the loan.
What PMI Costs
Rates typically fall between 0.5 and 1.5 percent of the total mortgage loan amount annually. PMI costs can vary depending on a variety of factors, including:
LTV Ratio
The percentage changes based on how much the home’s purchase price is financed. A 3 percent down mortgage will have a higher PMI rate than one where the borrower puts 10 percent down.
Credit Score
Your credit score is one of the key indicators lenders use in creating the details of your home loan, including the cost of PMI. An excellent credit score will put you in a lower-risk category, meaning lenders will give you a better rate on your PMI.
Loan Type
Different types of loans carry different levels of risk. If you finance a fixed-rate conventional loan, it has less risk than an adjustable-rate mortgage. That will be reflected in the amount you pay for PMI.
Do Credit Unions Require PMI for Home Loans?
Credit unions are member-operated financial institutions that offer similar products and services to commercial banks. They are structured similarly and use many of the same rules and regulations, including requiring private mortgage insurance for low LTV loans. That said, credit unions are created to serve their members. And as such, many of them offer a variety of programs to help members achieve their dreams of home ownership.
We know many first-time homebuyers need help coming up with the necessary down payment. That’s why we’ve created a first-time homebuyer program, especially for these members. It allows you to borrow up to 97 percent of the home loan or purchase price, whichever is lower. We also offer seed money mortgage assistance to fund your closing and down payment costs.
Want more information? Ask an expert! As a local credit union, we aim to help you navigate your finances using the best financial tools possible. How can we help you?
About Vermont Federal Credit Union
Vermont Federal Credit Union is a $900 million-plus full-service, not-for-profit, cooperative financial institution that has served Vermonters for more than 70 years, with eight locations currently serving over 50,000 members. Members are part of a cooperative, meaning they share ownership in the Credit Union and elect a volunteer board of directors. Vermont Federal Credit Union provides membership to anyone who lives, works, worships, or attends school in Vermont. Vermont Federal Credit Union is committed to supporting its communities and helping Vermonters prosper, no matter where they may be on life’s journey. Learn more about Vermont Federal Credit Union.
