How Is Mortgage Insurance Calculated?

When purchasing a home, you may as yourself, how is mortgage insurance calculated? You may wonder if you need mortgage insurance at all, and if so, how is this decided? Lenders are always measuring risks when it comes to assigning mortgage loans to borrowers. One of the major risks considered when underwriting your loan is the loan-to-value ratio, or LTV. If your LTV is greater than 80%, then the lender requires private mortgage insurance (PMI).

1. Calculating private mortgage insurance. Depending on your region and the housing market where you live, you can purchase a home with as little at 3.5% down. This sounds rather enticing for a borrower with little savings, but it comes with a high cost. When you put less than 20% down on your home purchase, you will need to pay mortgage insurance. This number is based on a percentage of how much you finance. The less you finance, the lower your PMI percentage.
2. Sample mortgage insurance calculation. If you are purchasing a home for $200,000, and put down 7% ($14,000) on a 30-year fixed rate loan, you will take out a loan that is 93% of the purchase price ($186,000). For a 30-year fixed rate loan between 90.01% and 95% of the home's value, PMI is 0.78%. To calculate your private mortgage insurance for this loan, you would make the following calculation: $186,000 x 0.0078 = $1450.80 annual PMI. Then you take your annual PMI and divide it into monthly payments: $1450.80 / 12 months = $120.90 per month.
3. The length of mortgage insurance payments. Until your loan is paid down to under 80% of your home's value, you will be required to pay mortgage insurance on your loan. When looking to purchase a home with a small down payment, you really need to consider the neighborhood in which you plan to purchase. If the community is stable and home values will likely appreciate over the next five years, then you will be making a good investment. If you home appreciates shortly after you purchase it, your likelihood of dropping your mortgage insurance sooner is great. However, if you purchase a home in a neighborhood that will not appreciate for several years, or is even depreciating in value, it would not be a wise decision to take out mortgage insurance. You could end up paying on it over the course of several years and lose money on your investment. 

Resources:

Federal Trade Commission