Though private mortgage insurance (PMI) implies additional costs, it can help people purchase a home without saving a lot of money for the down payment or depleting their emergency fund. Since insurance is an important part of a loan agreement, we’ll use this post to explain how to calculate PMI on a conventional loan. Before going into details, let’s take a look at the conventional mortgage structure.
The Components of a Conventional Mortgage Loan
A conventional loan includes four different components, such as:
- Principal – All loans are structured so that a greater portion of payment is dedicated to paying the interest during the first years. Since the amount of principal returned increases with each mortgage payment made, the payments will consist primarily of principal repayment in the final years.
- Interest – The amount of interest a borrower pays depends on the size of the mortgage and repayment time frame. A shorter repayment time frame will bring a lower interest rate.
- Taxes – The taxes a homebuyer must pay are calculated on a per-year basis and collected in an escrow account. Borrowers pay these taxes as part of their monthly mortgage payments.
- PMI – Conventional lenders require PMI when the down payment is less than 20 percent of the property value. The lender should automatically cancel PMI when the loan balance drops to 78 percent of the initial loan amount.
While these components are included in most conventional loans, some homebuyers prefer to make a large down payment or to pay taxes and insurance on their own to benefit from lower monthly payments.
Calculating PMI on a Conventional Loan
PMI depends on a series of factors, such as down payment, loan-to-value (LTV) ratio, credit score, repayment schedule, and overall loan profile.
To find out how much PMI a borrower must pay, he needs to calculate the LTV ratio. For example, if a person intends to buy a $150,000 house and puts down $10,000 (6.67 percent of the property value, 5 percent being the minimum accepted), he will owe the lender $140,000. To calculate the LTV ratio, he must divide the loan amount by the value of the property and multiply the result value by 100. Considering our example, we should divide $140,000 by $150,000 (0.93) and multiply by 100, which means 93 percent LTV. Once a borrower knows the LTV ratio, he can easily find out how much PMI he must pay by checking the lender’s PMI chart. As a general rule, an LTV ratio of 93 percent will warrant a PMI rate of 0.62 percent on a 30-year fixed conventional loan.
To calculate monthly PMI premium, a borrower must multiply the loan amount by the PMI annual rate (considering a 30-year fixed conventional loan, $140,000 x 0.0062 = $868 a year), then divide yearly PMI by 12 months ($868 / 12 = $72 per month).
A homebuyer can also find out exactly when the lender should terminate PMI by multiplying the value of the loan by 78 percent (e.g. $140,000 x 0.78 = $109,200). That means that the lender should cancel the PMI as soon as the remaining principal balance on a $140,000 conventional loan reaches the $109,200 threshold. If the lender doesn’t cancel PMI, the borrower can call him and explain that he’s already paid the required 78 percent of the initial loan value.
Since PMI also depends on the credit score, repayment plan, and overall loan profile, a potential homebuyer should submit a full loan application for an accurate PMI quote. For more details about conventional mortgage loans, contact our friendly advisors at North Florida Mortgage.