Borrowers who make less than a 20% down payment on a home loan typically must pay for private mortgage insurance (PMI). VA Loans don’t have this requirement, which can result in a lot of savings for the borrower.
What is Private Mortgage Insurance (PMI)?
Private mortgage insurance or PMI is an insurance policy that protects the lender if you default on the loan. If the lender must repossess the house and sell it for less than the amount remaining on the loan, they will be covered by this insurance. Essentially, the lender gets protected. You pay for that protection because the cost is added into your loan payment amount.
While that might seem annoying, it makes it feasible for banks to give you a loan without requiring as much of a down payment as they otherwise would. Before PMI was created, banks wouldn’t give loans to people unable to make a large down payment.
How the Amount is Calculated
The cost of private mortgage insurance varies depending on the total loan amount and the size of your down payment. It can range from around 0.3% to 1.5% of the original loan amount annually. For example, a $180,000 loan with $20,000 down might have an additional $52 added to each monthly payment to cover the private mortgage insurance fee.
Lenders must cancel private mortgage insurance when the loan-to-mortgage ratio drops to 78%. Borrowers can request it a little bit sooner, when the ratio reaches 80%.
Loan-to-value ratio is calculated like this:
Mortgage amount owed / appraised value
Example: $70,000 mortgage balance / $100,000 value = 0.70 or 70% loan-to-value
Loans with No PMI Required
The best way to avoid paying private mortgage insurance is to get a loan that doesn’t require it in the first place. You can do that by making a very large down payment so your loan-to-value ratio is 80% or lower from the start. Or you can get a type of loan that doesn’t require it.
VA loans don’t require private mortgage insurance. Because the government backs up these types of loans, the lender is protected already. Avoiding private mortgage insurance can save thousands of dollars over the life of a loan.