How is Private Mortgage Insurance Calculated?

Private mortgage insurance (PMI) is obtained by mortgage lenders to insure themselves against the expenses of foreclosure. If the down payment is sufficiently large, this insurance is not necessary because the expenses incurred can be recouped from the difference between the equity in the home and the money still owed.  But if your down payment is less than 20%, the lender will require you to pay for its own mortgage insurance until the equity in the house reaches 80%.

Generally, the higher the risk of loan default, the larger the premium will be.  The following factors are most significant in calculating private mortgage insurance premiums:

• Borrower’s credit rating – Naturally, the lower the credit rating the greater risk the loan is, and therefore the insurance premium goes up.  Borrowers with good credit ratings will pay less.
• Type of loan – Because of the added uncertainty, adjustable rate mortgages command higher premiums than fixed rate ones.
• Size of the loan – Default on a large loan will cause more damage than default on a small loan, therefore the larger the loan, the larger the PMI premium.
• Loan to value ratio (LVR) – This is the size of the loan as compared to the value of the property it is financing.  The larger the loan in relation to the value of the property, the greater the insurance premium.

Depending upon what the lender allows, premiums can be paid in a number of ways that affect the actual payment amounts.  Here are some of the most common PMI payment plans:

• Annual – The borrower pays a whole year of premium up front at closing, and then pays the premium on a monthly basis, with the mortgage payments, after the year is up.
• Monthly – The borrower pays a month or two of premium at closing and then pays the premium monthly.
• Single Premium – The borrower pays several years worth of premium up front at closing.  In such case it is very common to increase the loan amount to cover the premium’s expense with borrowed money.