PMI, or private mortgage insurance, is a type of insurance that is required by lenders when a borrower is unable to make a down payment of at least 20% of the purchase price of a property, or when an existing homeowner does not have at least 20% equity in their home. The purpose of PMI is to protect the lender in the event that the borrower defaults on their loan.
When a borrower makes a down payment of less than 20%, the lender is taking on a greater risk because the borrower has less invested in the property. If the borrower were to stop making payments on their home, which typically results in a default on the loan, the lender would have a harder time recovering their losses. This mortgage insurance is designed to mitigate this risk by providing an additional layer of protection for the lender.
PMI is typically required for conventional loans, which are not guaranteed by the government. However, there are also government-backed loans, such as FHA loans and VA loans, that may also require PMI. These loans have typically different down payment requirements, but they also have a form of mortgage insurance to protect the lender.
PMI is an important aspect of the appraisal process because the lender will use the appraisal to determine the value of the property and the loan-to-value ratio. The appraisal will be done by a licensed and certified appraiser who will physically inspect the property and compare it to other similar properties in the area to determine its value. The lender will also use the appraisal to verify that the property meets the minimum standards for the loan program.
One of the important things to note about PMI is that it is unlikely that your lender will notify you when you have at least 20% equity in your home. They have far too many loans to process and service and typically do not track every property's rising and falling values in their loan portfolios. Furthermore, most lenders sell off their loans to something called the ‘secondary market’ almost as soon as your loan is closed, so they won’t be reaching out to you to remove PMI. We wrote an article about how to get rid of PMI if you wanted to learn more!
The cost of Private Mortgage Insurance varies depending on the type of loan and the down payment, but it is typically a percentage of the loan amount and is added to the monthly mortgage payment. The cost will decrease as the borrower pays down the loan and the equity in the property increases.
PMI can also typically be removed once the borrower reaches a certain level of equity in the property. Typically, this happens when the borrower reaches a loan-to-value ratio of around 78%. The loan-to-value ratio is the amount of the loan divided by the value of the property. Once the borrower reaches this threshold, they can ask the lender to cancel the PMI, and the monthly mortgage payment will decrease.
As an example: If an existing homeowner’s home is valued at $400,000 and the amount still owing on the bank loan is only $300,000, the owner can be said to have $100,000 in equity in their home, or 25% equity based on the loan to value ratio. Conversely, if that same home is valued at $400,000, but the amount still owed to the bank is $350,000, then the owner only has a 13% equity stake in the property and the loan would still require PMI to remain on the loan.
If you think you have at least 20% equity in your home, it may be worth reaching out to your lender to inquire what the process is to have it removed. True Footage appraisers field calls daily on this topic and always make sure to inform the caller that its best to reach out to your lender first as many lenders will need to order the appraisal directly from True Footage. We would hate to have you pay for an appraisal that you can’t use with your lender in the event that they have to order the appraisal directly.
Blaine Feyen is the Head of Community at True Footage. Born and raised in Michigan, Blaine has been in the real estate and related industries for over 30 years. Buying his first duplex at 18, Blaine has been a Realtor, Lender, Investor, Builder, and 20+ year Appraiser. Blaine built and sold three appraisal firms over the years, and has coached many other Appraisers in building their companies as well. Blaine holds a fifth-degree black belt in Aikido and spends his free time doing Brazilian Jiu-Jitsu, riding motorcycles, recording podcasts, and writing.