PMI: What is it? Do I Need it?

How to determine which type of PMI is best for you

In today's market, saving for a 20% down payment can mean putting your home buying dreams on hold. Fortunately, there's an option for buyers to put down less than 20% by utilizing private mortgage insurance, also known as PMI.

What is Private Mortgage Insurance?

Private Mortgage Insurance, or PMI, is an added insurance policy that lowers a lender's risk when lending to buyers that aren't putting down 20% on their home purchase. Why is the 20% so important? One of the factors taken into consideration when applying for a mortgage is the loan-to-value or LTV ratio. We've covered LTV in-depth on our blog, but put simply it measures the market value of your new home against the amount of the loan and helps lenders calculate the risk they're taking when offering you a loan. A higher upfront investment from a borrower is less risky for a lender, but PMI can help offset the risk for situations in which borrowers aren't putting 20% down.

There are four types of private mortgage insurance available to borrowers:

Borrower-Paid Mortgage Insurance (BPMI)

This is the most common type of PMI, and shows up in the form of an additional fee that's added to your monthly mortgage payment. You continue to pay BPMI regularly until you've accumulated 22% equity in your home, which occurs through regular mortgage payments, appreciation of your home's value, or in most cases a combination of both. This means that 

While PMI can be a great option for buyers that aren't prepared with a 20% down payment, keep in mind that it can take several years to pay off PMI. That means the extra monthly expense will likely be with you for some time. You can consider options for refinancing down the road to get rid of PMI if that makes sense financially.

Single-Premium Mortgage Insurance (SPMI)

Also known as single-payment mortgage insurance, with this option you pay your entire PMI sum up front, rather than monthly with your mortgage payment. The benefit here is a lower monthly payment, which can equate to qualifying for a higher loan amount to put toward your home purchase.

This option is the best fit for buyers who are planning to stay in their home for a long time. The single payment isn't refundable, so if you decide to refinance or sell your home within a few years, you won't recoup anything you've paid in SPMI.

Lender-Paid Mortgage Insurance (LPMI)

With this option, your lender is paying for your PMI in exchange for a higher interest rate on your loan. This is another instance in which you could still have a lower monthly payment than with BMPI and therefore qualify to borrow more. The downside is that this higher interest rate is built into your loan, so you won't reach a point where you stop paying it unless you refinance.

Split-Premium Mortgage Insurance

While this option may be the least common, it can be a good middle ground for some buyers. In this instance, a borrower splits their PMI cost between a lump sum at their closing and a lower monthly payment to cover the remaining amount. This works well because it's a lower upfront cost as well as a lower monthly payment, which might be needed to qualify for the mortgage in the first place, particularly in cases where the borrower has a high debt-to-income ratio.

If a 20% down payment isn't the right fit for you at this time, ask your lender to discuss PMI options with you to determine which might work best in your situation. Acadia Lending Group is here to help walk you through the entire process.

Watch this super quick video for a simple rundown: