When you buy or refinance a home, your lender may ask for proof of mortgage insurance and homeowners insurance. Although they sound related, mortgage insurance is not the same as homeowners insurance. Both types of insurance protect different things. There are situations where one or both might be required, both payable by the borrower.
Mortgage Insurance versus Home Insurance
The critical contrast between contract protection and home protection is who it secures. Property holder’s protection basically safeguards the borrower, while contract protection safeguards the moneylender.
Homeowners insurance protects the structure of your home and your property from most financially devastating losses, such as fires or storms. If your home is damaged, homeowners insurance may pay you directly for losses. Mortgage insurance, or private mortgage insurance (PMI), protects the mortgage lender against the borrower not repaying the private loan, especially in circumstances where they make less than the standard 20% down payment.
Some types of loans require mortgage insurance for the life of the loan, while others allow you to pay off after paying off a portion of the mortgage. PMI is generally required until enough of the mortgage has been paid off that you are no longer considered a subprime borrower.
Mortgage insurance
When you take out a loan to buy or refinance a home, a bank or lender takes the risk that you will default on your mortgage.
Lenders look for low-risk borrowers with:
- good credit history
- stable employment
- Low debt-to-income ratio
- A down payment of 20% or more of the selling price of the property
Many borrowers check all the boxes, but don’t have the funds to pay the 20% to purchase their property. A lender might see this as a red flag. Someone who does not invest a significant amount of their income in their property may not be as committed to making long-term mortgage payments in the eyes of lenders. That’s where PMI comes in.
What is PMI?
Private mortgage insurance (PMI), or PMI, protects a bank or lender if you don’t pay your mortgage and leave the house. PMI gives a bank or lender a guarantee that their risk will be covered for lending you money.
PMI is generally required when you have a conventional mortgage loan and make a down payment of less than 20 percent of the home’s purchase price. When refinancing, if your home’s equity is less than 20 percent of your home’s value, you’ll also be required to bring PMI.
How much does PMI cost?
The average annual cost of PMI is usually between 0.5% and 1% of the loan amount. A $250,000 mortgage could cost you up to $2,500 per year or an additional $208 per month. According to the Consumer Financial Protection Bureau, PMI is most commonly paid as part of the monthly mortgage premium, but can be paid as an initial premium at closing. You can find out the terms of your PMI by reviewing your loan estimate and closing disclosure.
PMI is arranged by the lender and provided by private insurance companies. A lender may or may not offer you payment options, but you can request some. The most common ways to pay PMI are:
- A monthly premium added to your mortgage payment
- A single initial premium paid at closing
- A combination of a down payment and monthly premiums
How can I avoid paying PMI?
There are several ways to avoid paying PMI:
- Save more: By delaying your home purchase and saving a larger down payment, you could avoid having to pay PMI.
- Ask the lender to pay: Some lenders will cover the cost, known as lender-paid mortgage insurance (LPMI). However, there is a tradeoff because you could have a higher interest rate on your mortgage if you go this route.
- Get a piggyback mortgage: Instead of getting one mortgage, you could have two. This is most often done in an 80/10/10 split, with an 80% first mortgage, a 10% second mortgage, and a 10% down payment.
- Find a lender with its own program: Some lenders offer low down payment options with no PMI. This could be for first-time homebuyers, low-income buyers, or people in certain professions, like doctors or teachers.
- Use a Veterans Affairs (VA) loan: If you qualify for a loan through the Department of Veterans Affairs, you may be able to get a mortgage with no down payment and avoid paying PMI.
