If you’ve been considering a mortgage, you’ve likely run across the term PMI. But you might be unsure of exactly what it means or how it can have an effect on your bottom line. Here, Forbes discusses what PMI is, how it’s paid and how you can avoid it.
What is PMI?
Private mortgage insurance—also known as PMI—is an extra monthly fee that protects the lender from a loss in case you default on the loan. Federally backed loans, or FHA loans, also have a similar requirement known as the mortgage insurance premium (MPI). But unlike conventional loans, where you can usually get rid of your mortgage insurance requirement over time, FHA buyers are required to keep up their MPI payments for the entire life of the loan.
How is PMI charged?
This premium typically is included as part of your monthly mortgage payment. That means that though you’re paying slightly more than you would be without it, you don’t have to worry about writing another check each month. PMI also can be collected in one lump-sum at settlement, meaning that you’d have the choice between paying in cash-on-hand or rolling the payment into your loan amount. You also may experience a mix of both upfront and monthly payments.
When can you stop paying PMI?
Most lenders allow you to drop your PMI once you’ve built up at least 20 percent equity in your home and have a loan-to-value ratio of 80 percent. How long it will take you to get there depends on factors such as the size of your monthly mortgage payment, as well as your down payment. Lenders sometimes will have a few additional stipulations that you must meet to get rid of your PMI requirement. For example, you could be required to have a history of making your mortgage payments on time or they may not allow you to drop the requirement if you have a second mortgage.
How can I avoid PMI?
The easiest way to avoid paying PMI is to have the requirement waived altogether. You can do this if you’re able to make a large enough down payment that covers 20 percent of the loan and gets you an 80 percent loan-to-value ratio from the beginning.