What Is Private Mortgage Insurance (PMI)

If you look at your monthly mortgage statement and see a line for “PMI,” you’re paying for private mortgage insurance. It probably costs you between $50 and $200 per month, depending on the balance of your loan and your PMI rate.

But why are you paying it? Essentially, your lender is requiring you to pay the premiums for an insurance policy that partially reimburses them should you default on your mortgage. We’ll discuss when you’re required to have PMI, what this insurance protects, who needs to carry it, and ways to avoid paying it.

Loan to Value (LTV) Ratio

The loan to value (LTV) ratio is what the lender looks at to determine whether or not you need to pay PMI, and when you can stop paying it. To calculate this ratio, take the amount of the loan and compare it to the current value of your house. For example, if your mortgage is $150,000 and your home is currently worth $200,000, your loan to value ratio is 75%

What Is Private Mortgage Insurance?

When you apply for a mortgage, the lender wants to make sure your home will have enough equity to pay off the loan balance should you default and go into foreclosure. But since foreclosed upon homes are often sold at a “discount,” lenders want a buffer of at least 20%. In other words, they want to be reasonably sure they can recoup the money they loaned you if the home has to be sold at a lower price than the original sales price.

However, this doesn’t mean that lenders are unwilling to write loans when you put down less than 20%. They just charge you more for the privilege via PMI. In this way, you get a mortgage, and they minimize their risk in offering you a loan. Private mortgage insurance is an actual insurance policy issued by an insurance company that benefits your lender. If your home goes into foreclosure and the lender is not able to recoup the outstanding balance by selling the home, the insurance company that issued your PMI will pay the lender the difference.

PMI is called “private” because it is only offered to private companies and not government agencies or public mortgage lenders. Public programs, such as the FHA and VA mortgage programs, have their own mortgage insurance, but it is run differently and managed internally. However, one notable difference between PMI and mortgage insurance attached to many FHA and VA loans is that the latter never expires. In other words, you will continue paying mortgage insurance on FHA and VA loans even after your loan to value ratio has dropped below 80%.