Do Conventional Loans Require Private Mortgage Insurance?

Are you considering a conventional loan for your home purchase but concerned about the Private Mortgage Insurance (PMI) requirement? Understanding how conventional loans require PMI can help you make informed decisions about your mortgage options. In this guide, we'll delve into the details of PMI and its implications for conventional loans. We'll explore the factors that determine PMI, the benefits it offers, and strategies to potentially eliminate or reduce PMI payments. By the end of this guide, you'll have a clearer understanding of how PMI works with conventional loans and how it may impact your home buying journey. Let's get started!

Understanding the Basics of Conventional Loans

Understand the key features of conventional loans by exploring their basics. Private lenders offer these loans and require PMI if the down payment is less than 20% of the home loan value. Your credit score determines the mortgage payment and interest rate.

Conventional loans differ from FHA and VA loans in that they don't have government backing, which may result in a higher interest rate. You can cancel PMI once you've built enough equity in your property. Make a larger down payment to avoid PMI, or factor in the cost of PMI when calculating your mortgage payment. By knowing the fundamentals of conventional loans, you'll be able to make an informed decision on your home loan.

What is private mortgage insurance (PMI)?

Private mortgage insurance (PMI) is required for conventional loans when the borrower makes a down payment of less than 20%. You, the borrower, pay for PMI to safeguard the mortgage lender in case of default on loan payments. PMI is usually required for conventional loans when your down payment is less than 20% of the loan balance. This insurance usually gets included in your monthly mortgage payment and varies depending on the loan type, interest rates, and loan balance size. USDA loans typically don't require mortgage insurance.

When you buy a home and can't put down at least 20% of the purchase price, mortgage lenders may require mortgage insurance. The annual premium varies based on loan terms, loan balance size, and credit score.

Once your loan balance reaches 78% of the original purchase price, you may be able to cancel PMI. You must meet specific requirements, prove your loan balance has been paid down, and receive approval from the mortgage lender to cancel PMI.

How PMI Works with Conventional Loans

If a borrower defaults on a conventional loan, the lender is safeguarded by private mortgage insurance (PMI) coverage. It is often necessary when a borrower puts down less than 20% of the home's cost. PMI payments typically vary from 0.3% to 1.5% of the loan balance each year.

In contrast, an FHA mortgage requires borrowers to pay upfront and annual mortgage insurance premiums. Upfront mortgage insurance is a one-time payment typically needed for loan closing costs. The annual mortgage insurance premium is paid in 12 monthly installments as part of the borrower's monthly mortgage payment.

To pay PMI, borrowers are required to make an escrow account payment along with their monthly mortgage payment. The lender holds this payment, which is used to pay the PMI premiums when they are due. Borrowers can also pay the PMI premiums directly to the lender. However, this is typically not recommended, as tracking when the premiums are due can be challenging.

The PMI can be canceled when the loan amount is paid down to 78 percent of the original purchase price. Borrowers should contact their lender to confirm when the PMI can be dropped from the loan.

Does every conventional loan require PMI?

The payment of PMI, or mortgage insurance, is not necessary for all conventional loans. Depending on the loan you get and how much of a down payment you put down, you might or might not have to pay for PMI. PMI might be necessary if your down payment is less than 20% of the home's appraised value.

A piggyback loan or a one-time premium for mortgage insurance are two alternatives, though. The type of mortgage insurance you must pay for and the circumstances under which you might be able to cancel it should be understood. More details on whether or not you must pay and how much you must pay can be found in our guide to private mortgage insurance.

Private Mortgage Insurance Options for Conventional Loans

Of course, the borrower is responsible for paying the cost of the private mortgage insurance. There are four payment options with private mortgage insurance. The PMI cost considers an applicant's credit score, down payment amount, and several other variables.

Borrower-paid mortgage insurance (monthly)
Single-premium mortgage insurance
Split-premium mortgage insurance
Lender-paid mortgage insurance

Borrower-paid private mortgage insurance (monthly)

Without question, the most popular payment plan is the monthly mortgage insurance option. Probably because it's the easiest for the loan officer. The PMI premium is billed annually, and the lender collects 1/12 of the annual premium and includes the cost with the mortgage payment.

Single-premium private mortgage insurance

Private mortgage insurance with a single premium, or PMI, is purchased in one lump sum when obtaining a mortgage. When a borrower defaults on a loan, it is intended to protect the lender from financial loss. For the duration of the loan, the insurance covers the entire amount of the loan after the borrower pays a one-time premium, typically at closing. The borrower may save money with this PMI because it doesn't require regular payments.

Split-premium private mortgage insurance

The split-premium mortgage insurance blends the monthly mortgage insurance premium with the single-premium mortgage insurance. There is an upfront payment at closing and a reduced monthly payment.

Lender-paid private mortgage insurance

Private mortgage insurance (PMI) paid for by the lender instead of the borrower is referred to as lender-paid PMI. This type of PMI is typically offered to them to help borrowers with lower down payments or credit scores still qualify for mortgages.

The borrower pays the lender back over time as part of their monthly mortgage payments after the lender pays the upfront cost of the PMI. Even though this kind of PMI is typically more expensive than borrower-paid PMI, there are circumstances where it may be advantageous.

Understanding PMI Cancellation and Termination

PMI cancellation and termination is the process of removing or canceling private mortgage insurance (PMI) when the homeowner has acquired enough equity in their home. PMI is an insurance policy that protects the lender if the borrower defaults on the loan. PMI is typically required on loans with a down payment of less than 20% of the home’s value.

Cancellation and termination of PMI are based on the loan terms and the loan balance relative to the home’s value. In general, PMI can be canceled once the loan balance reaches 78% of the home’s value at the time of purchase.

You can qualify for a conventional loan that doesn't need PMI if your mortgage balance exceeds 80% of your home's current assessed value. But alternative lending choices may require you to pay PMI to get the loan if you don't qualify for a traditional loan. One of these loan options is FHA mortgage insurance, which entails the borrower paying an upfront mortgage insurance payment and yearly mortgage insurance premiums.

Be aware of the costs associated with PMI upfront and over the loan's life to make the best decisions for your financial situation. You can qualify for a loan with a 20% down payment or more and avoid PMI altogether. Understand the terms of your loan and the options available to you to determine when it is best to cancel or terminate PMI, as PMI can significantly add to the cost of homeownership.

Conclusion

While conventional loans typically require Private Mortgage Insurance (PMI) when the down payment is less than 20%, it's important to remember that PMI serves a purpose in providing access to affordable homeownership for many borrowers. By understanding how PMI works and exploring strategies to minimize its impact, you can make confident decisions when considering a conventional loan. Remember to evaluate your financial situation, explore down payment options, and consult with a trusted mortgage professional who can guide you through the process. With the right knowledge and support, you can navigate the world of conventional loans and achieve your homeownership goals.

SOURCE:
Consumer Financial Protection Bureau
Termination of Conventional Mortgage Insurance
Mortgage Insurance Coverage Requirements