Buyers often want to know, “Is PMI based on appraised value?” The answer is not necessary. The Private Mortgage Insurance (PMI) calculation depends on the purchase price and the appraisal. The guideline is that PMI is based on the lesser of these amounts.
Let’s compare two similar examples:
- A home has a purchase price of $300,000 and the appraised value is $310,000. Here, PMI will be based on the lower purchase price.
- A home has a purchase price of $300,000 and the appraised value is $290,000. Here, PMI will be based on the lower appraisal value.
How Is PMI Affected by Appraisal?
A realistic home appraisal is critical to mortgage approval and how much the bank is willing to lend you. If you can’t afford a 20% deposit, then you’ll have to take out PMI. This doesn’t benefit you at all but protects the lender if you default.
Without a good appraisal, you won’t be granted a home loan, never mind having it extended to make up any shortfall in your deposit. To get PMI, your appraisal must be close to or better than the purchase price. Even a good credit score can’t help you if the purchase price is too high!
Who Is The Provider of PMI?
A lender organizes PMI directly with their provider of choice, so your PMI depends on which company your bank chooses. You don’t have a say in this and the PMI is added directly to your loan, with its premium built into your repayment schedule.
Currently, there are only seven U.S. mortgage insurers that protect lenders across the country. These companies operate nationwide and even internationally. Some are based in Bermuda. The mortgage insurers are Arch Capital Group, Essent Guaranty, Genworth Financial, The Mortgage Guaranty Insurance Company (MGIC), National Mortgage Insurance, Old Republic International, and Radian Guaranty Inc.
How Much Does PMI Cost?
The average cost of PMI is 0.22% to 2.25% of your mortgage amount, depending on your credit score. This can substantially increase the number of your repayments. For example, if you have a loan of $250,000, then you would pay a PMI of $550 to $5,625 annually, or $45.83 to $468.75 monthly.
You can pay the full cost of PMI when you close on the loan. This adds to the closing cost, but your monthly mortgage repayment will be lower. You can also opt to pay part upfront and smaller monthly payments thereafter.
Estimate Value Through an Appraisal
If you’re applying for a mortgage loan, your lender will require you to get a home appraisal. You need this to determine a fair price and calculate PMI if you don’t put 20% equity into the property by way of a deposit. The average fee can range from $400-$500 on a typical home (depending on the soiree footage and details of the home).
You can find various appraisal calculators online. These automated valuation models (AVMs) may give you a ballpark figure of the property’s value but are not entirely reliable. It’s much better to perform the following 5-step calculations:
- Calculate the cost-per-square-foot: Divide each comp’s selling price by the size of the property.
- Estimate your home’s value: Add all costs-per-square-foot, then divide this sum by the number of comps. Multiply your home’s square footage by this number.
- Find the range: Calculate 10% less and more to get your estimated home value appraisal range.
- Estimate your PMI: Ask your lender what your PMI percentage is and multiply this by the property value.
Determine the Loan-to-Value Ratio (LTV)
LTV is a financial ratio that compares the amount of money borrowed to the market price of the property purchased. It assesses the risk that the lender takes in granting you a mortgage.
If you put down a 20% deposit, then the amount of money you borrow is 80% of the purchase price. This is the cutoff LTV for avoiding PMI. Any smaller down payment will result in an LTV higher than 80%. To calculate your LTV, take your current loan balance and divide it by the current appraised value. Multiply this number by 100 to convert it to a percentage and round it up to the nearest whole number.
The smaller your deposit, the higher your LTV and the lower your credit score, the greater the risk associated with your loan. This means that you’ll have to pay a higher PMI. This has pros and cons, as follows:
Pros of PMI:
- A smaller deposit is required to buy a home.
- Access to financing due to the lender’s risk being insured.
- Improve your credit score with on-time monthly payments.
Cons of PMI:
- Higher monthly repayments.
- Doesn’t add equity to the property.
- Can only be canceled once you’ve built up at least 20% equity.
Conventional Loans with No PMI
The criteria for conventional or conforming loans are set by Fannie Mae and Freddie Mac. These two large companies together make up the government-sponsored enterprises (GSEs) that guarantee most mortgages in the U.S. They buy mortgages from lenders and then sell them on to investors. In this way, lenders free up their funds so that they can offer more loans to qualified buyers.
Conventional loans where you aren’t required to pay PMI offer better interest rates and repayment terms. This kind of financing usually requires a 20% deposit, a healthy credit score of at least 620, plus a debt-to-income ratio (DTI) smaller than 50%. A final requirement is that the amount of money you wish to borrow must fall within the annual loan limits set by Fannie Mae and Freddie Mac. For most states, the single-family baseline loan limit for one unit is $726,200 for 2023.
When buying a home, all the calculations and requirements can be quite complex and confusing. People often ask three common questions when contemplating PMI. These are: “Is PMI based on appraised value?”, “Is PMI based on the loan amount or appraisal?”, or “Is PMI based on the purchase price or appraised value?” As explained in this article, PMI is always based on the lower purchase price or appraisal.
As a prospective homebuyer, you should gather as much information as possible to make smart decisions. Take the time to understand terms, such as PMI and LTV.
If you need help, find trustworthy experts who will offer sound advice and guide you through the home valuation process.