Borrowers who take out a loan to buy a property with less than a 20% down payment are likely to have to pay PMI. PMI is short for Private Mortgage Insurance. This is an insurance policy that the lender requires the borrower to take out to protect the lender from losing money. This insurance policy pays out to the lender if the borrower defaults on the mortgage and there is a deficit between the outstanding balance of the loan and the amount recovered from the sale of the property in a foreclosure sale.
Lenders & Down Payments
When you take out a loan to buy a property, the lender wants assurance that they will be able to get their money back in the advent of a foreclosure. If the property is foreclosed on, the lender will attempt to recoup their money through selling the property. Since foreclosures often sell at a discount to the original home value,the Lender usually protects themselves by requiring that you make a substantial down-payment on the property. This way the lender will still be able to recover the full value of the loan even if the property ends up selling for less than its original purchase price. In most cases a 20% down payment is the required margin of safety.
PMI Reduces the Lender’s Risk
A loan with a smaller than 20% down payment is more risky for the lender because the chances that the lender will be able to recover the full value of the loan in a foreclosure sale are reduced. Lenders are often still willing to lend money to buy properties with a smaller than 20% down payment, but they will usually require that you pay P.M.I. in order to do this.
Loan To Value Ratio
PMI is determined by the Loan-To-Value Ratio. This ratio is computed by dividing the balance of the loan by the price of the property. For example, if you take out a mortgage for $190,000 to buy a property that costs $200,000 with a down-payment of $10,000 the loan-to-value ratio would be 190,000 / 200,000 = 95%. Usually, P.M.I. will be required if the loan-to-value ratio is higher than 80%. A higher loan to value ratio (corresponding to a lower down-payment) will usually increase the PMI rate. That is, the PMI rate will generally be higher for a 97% loan-to-value ratio than for say a 90% ratio.
How Do I Stop Paying PMI
With conventional loans, the borrower usually has to pay the PMI premium until the loan to value ratio is below 80%. Once the borrower has paid enough of the balance down so that the loan-to-value ratio is 78% or lower based on the original purchase price of the home the lender is required to automatically cancel the PMI for conventional loans. If a home-owner believes that their property has apreciated enough to bring the loan-to-value ratio below 80%, the home-owner may be able to have the property re-apraised and petition the lender to drop the PMI requirement early.
Use this PMI Calculator to estimate the monthly PMI payment for a loan.