5 Misconceptions About Private Mortgage Insurance in California

Private mortgage insurance, or PMI, is one of those subjects that tend to create a lot of confusion among first-time home buyers in California. And it’s easy to understand why.

For one thing, PMI is one of the only types of insurance that doesn’t actually insure the person who pays for it. Additionally, it’s only required in certain scenarios, making the subject even more complicated to a first-time buyer.

In this article, we will explain how private mortgage insurance works in California, while clearing up some of the common misconceptions and misunderstandings surrounding PMI.

Private Mortgage Insurance in California

Private Mortgage Insurance (PMI) is a form of insurance lenders require when a loan accounts for more than 80% of the home’s value. It protects the lender in case the borrower defaults on the loan, reimbursing the lender for a portion of the outstanding balance.

PMI is paid by the borrower as part of their monthly mortgage payments (in most cases) or as a separate premium. It allows home buyers to obtain a mortgage with a smaller down payment, thereby reducing one of the biggest hurdles to homeownership.

The cost can vary due to the size of the loan, the down payment amount, the borrower’s credit score, and other factors. The average annual cost of private mortgage insurance in California typically ranges from 0.5% to 1.5% of the loan amount (divided into 12 monthly payments). PMI can be canceled once the homeowner reaches 20% equity in their home.

Clearing Up Some Common Misconceptions

With that introduction out of the way, let’s debunk some of the most common “myths” and misconceptions relating to private mortgage insurance in California.

Misconception #1: Mortgage insurance is the same as homeowners insurance.

This is an easy one to clarify, so we won’t spend too much time on it. The truth is, mortgage insurance and homeowners insurance are two totally different things. They have no connection whatsoever.

Mortgage insurance protects your lender in case you default on your loan. It is typically required if you make a down payment of less than 20% on your home, resulting in a loan-to-value ratio above 80%. Mortgage insurance does not cover your home or your personal belongings in any way.

Homeowners insurance protects your home and your personal belongings from financial loss due to a variety of perils (including fire, theft, windstorm and hail). It can also provide liability coverage, which protects you if you are sued for accidental injury or property damage that you or your family members cause to others. But it has nothing to do with your mortgage loan.

Misconception #2: You have to put down 20% or more to avoid PMI.

Contrary to popular belief, you don’t necessarily need a 20% down payment to avoid private mortgage insurance in California. While an LTV ratio above 80% typically triggers the PMI requirement, there are ways to bypass it even with a down payment well below 20%.

For instance, some California home buyers employ a “piggyback” loan strategy. They secure a first mortgage that covers 80% of the purchase price and take out a second loan to cover an additional 15%. The remaining 5% is paid as a down payment.

In this scenario, neither of the two mortgage loans exceeds 80% of the home’s value, thereby eliminating the need for private mortgage insurance. Remember, it’s the loan-to-value ratio that primarily determines whether you have to pay for mortgage insurance in California.She’s

Misconception #3: These policies only benefit the lender.

While it’s true that private mortgage insurance increases your monthly payments, it offers several significant benefits to home buyers in California. For one thing, it provides an easier and faster path to homeownership.

If the PMI industry ceased to exist, a 20% down payment would likely become the minimum requirement for most home buyers in California. Private mortgage insurance enables lenders to offer low down payment options by mitigating the additional risk they bring.

In essence, PMI helps California home buyers purchase a home sooner and with less money down. It serves as a facilitator rather than an obstacle to homeownership.

Misconception #4: The premiums are the same for everyone.

Mortgage insurance premiums in California can vary from borrower to borrower. PMI employs a risk-based pricing model, similar to many other financial products. Factors such as down payment amount and credit score influence the premium rates.

Generally, borrowers with larger investments and higher credit scores are considered lower risk and may qualify for lower PMI premiums. So a higher credit score or a larger down payment can potentially lead to reduced PMI costs. While other factors come into play as well, these two factors carry significant weight in determining mortgage insurance pricing.

Misconception #5: Mortgage insurance lasts as long as you keep the loan.

Homeowners with PMI policies can cancel them once the loan-to-value ratio falls to 80% or below. As homeowners make regular monthly payments, their equity in the home naturally increases over time, reaching the point where PMI can be canceled.

But it’s important to note the distinction between private and government mortgage insurance, as the rules regarding cancellation differ.

Conventional loans (which do not receive government insurance or guarantees) are subject to private mortgage insurance. With conventional financing, homeowners can cancel the PMI when their home equity rises to 20% or above.

For FHA loans (which are insured by the federal government), borrowers generally have to pay their annual mortgage insurance premiums for the life of the loan.

If you’re planning to buy a home in California and have PMI-related questions, please contact our staff. We can review your financial situation and home buying goals to determine the best path forward!