This guide explains what it means to be "pre-approved" by a lender, how the process…
5 Misconceptions About Private Mortgage Insurance in California
Private mortgage insurance (PMI) tends 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.
This guide explains how private mortgage insurance works in California, while clearing up some common misconceptions about this subject.
Here are five of the most important points covered in this guide:
- PMI protects the lender, not the borrower, and is usually required when the down payment is less than 20%.
- Mortgage insurance is not the same as homeowners insurance—they serve completely different purposes.
- You don’t always need a 20% down payment to avoid PMI; some buyers use second loans to sidestep it.
- PMI can help buyers purchase a home sooner by reducing down payment requirements, making homeownership more accessible.
- PMI costs vary based on credit score, down payment, and other factors. It can be canceled once you reach 20% home equity.
Overview of Private Mortgage Insurance in California
Private mortgage insurance (PMI) is a form of insurance lenders require when a conventional home loan accounts for more than 80% of the property value.
PMI protects the lender in case the borrower defaults on the loan. “Default” is when a homeowner can no longer repay the mortgage debt. Mortgage insurance reimburses the lender for a portion of the outstanding balance.
In California, homeowners typically pay for PMI as part of their monthly mortgage payment. It’s one of the four primary components that make up a mortgage payment, along with the principal, interest, and taxes.
- The downside: PMI increases the size of a homeowner’s monthly payments, in those cases where it’s required.
- The upside: It allows home buyers to put less money down, reducing one of the biggest hurdles to homeownership.
The cost of PMI can vary due to several factors. The average cost in California ranges from 0.58% to 1.86% of the loan amount (divided into 12 monthly payments).
Five Common Misconceptions About PMI
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: It’s the same thing 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.
The takeaway: Private mortgage insurance protects the lender from potential losses, while homeowners insurance protects the homeowner from potential losses. Two separate things.
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 a loan-to-value (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.
The takeaway: When a home loan accounts for more than 80% of the property’s appraised value, the borrower usually has to pay for private mortgage insurance.
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 it brings.
The takeaway: 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. So your lender should tell you up front how much it will cost (assuming you need PMI).
Similar to many other financial products, mortgage insurance employs a risk-based pricing model. Factors such as the down payment amount and borrower’s credit score can 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.
The takeaway: Generally speaking, borrowers who are perceived to be a bigger risk to the lender will pay more for PMI. Those who are considered to be a lower risk might pay less.
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.
The takeaway: Borrowers with conventional loans can usually cancel PMI at 20% equity, but some FHA borrowers must keep mortgage insurance for the life of the loan.
Have Mortgage Questions?
Bridgepoint Funding works with multiple mortgage lenders. This gives us access to a wider range of home loan products, some of which have very flexible qualification requirements.
Our business model allows us to choose the best financing option for each individual client. We can also help you determine if you’ll need to pay for mortgage insurance, based on your down payment and other factors.
Please contact our staff with any questions you have or to apply for a loan!
