Private Mortgage Insurance (PMI) Explained

Private Mortgage Insurance (PMI) is insurance that borrowers pay to a lender to ensure that if a home loan is not repaid (a default), the lender will be compensated for the loan amount. A home buyer who doesn’t put enough money down on a home is the one who pays the PMI. Most of the advantages of PMI reside with the lender, but there is one advantage to borrowers — it enables them to purchase homes with 3 to 5 percent of the home price.

PMI is only paid on a home where less than 20 percent of the appraised value or sales price is given as a down payment. If a home buyer put down 5 percent and later defaults on the loan, the insurance company that sold the PMI would pay the bank the 15 percent to reach the 20 percent threshold.

The PMI premium is part of your monthly mortgage payment. How much is added depends on the down payment. The industry-standard calculation figures below help determine your PMI:

Down Payment	Divide Mortgage Amount by This Number to Get Monthly PMI
5 percent	1,500
10 percent	2,300
15 percent	3,700

An Example of Using the Formula:

Purchase Price of Home: $200,000

Down Payment: 10 percent ($20,000)

Mortgage: $180,000 ($200,000 minus $20,000)

To figure your monthly PMI: $180,000 divided by 2,300 equals $78.26 per month

With some exceptions, PMI drops off your monthly payment once you have paid down your mortgage loan to 78 percent of the original purchase price or appraised value (whichever is less) of your home at the time you got the loan.

The Homeowners Protection Act of 1998 established rules for when a lender must automatically cancel mortgage insurance. According to the act, when a homeowner reaches 22 percent equity in a home, then the PMI must be terminated. This figure is based on the original property value of the home. In other words, a lender will cancel your PMI when you reach a 78 percent loan-to-value ratio.

While the law is good because it helps prevent homeowners from overlooking when they can drop PMI and begin putting more money into their pockets, they should request that PMI be dropped when they’ve paid down loans to 80 percent to avoid paying any extra PMI payments. Those two percentage points — 80 percent vs. 78 percent — can add up to a few hundred dollars in savings by not paying the PMI for a few months, depending on the size of the loan.

Because the law applies only to residential mortgages signed on or after July 29, 1999, when the act took effect, mortgage holders who signed before that should do their due diligence to see when they’ve reached the 80 percent threshold on their own loans.

The Homeowners Protection Act of 1998 doesn’t apply to government-insured FHA or VA loans. Similarly, high-risk borrowers are not protected by this law. In fact, lenders can continue to require PMI from a borrower in this category all the way to 50 percent equity.

What are the origins of PMI? The answer is simple: Lenders know that a buyer who puts less than 20 percent down on a house is more likely to default on it. This fact is based on historic industry figures. Yet some mortgage companies let you pay down the cost of your PMI at the time of your loan, much in the same way that paying points can lower your interest rate.

If you closed on your loan before July 29, 1999, and the Homeowner’s Protection Act of 1998 doesn’t apply to you, you may likely be able to get your lender to remove your PMI if you have at least 20 percent equity in the home.

To understand the particular terms your lender has written into your mortgage, carefully review your mortgage disclosures and consult one of your lender’s mortgage specialists.