June 29, 2018
June 29, 2018
Most people are aware that your credit score will affect the interest rate that you will pay on loans. But what’s less well-known is that your credit score affects the PMI premium you will pay on a mortgage. PMI, also known as private mortgage insurance, is a mortgage lender requirement on low down payment loans.
The premiums that you will pay for PMI are adjusted based upon the credit score range that you fall into. The difference in that premium from one credit score range to another can be significant. In fact, it can amount to tens of thousands of dollars over the life of the loan.
PMI is required on conventional mortgages where the borrower has less than 20% equity in the property. Expressed another way, it is required any time the mortgage on a property exceeds 80% of the property value.
Mortgage lenders will require PMI to reduce their risk on such loans. The general experience on mortgages is that the default rate increases as the borrower’s equity falls below 20%.
PMI is an insurance policy that pays the lender in the event that you default on the loan. They don’t pay the entire loan amount, but rather a certain percentage. Since lenders are generally able to recover much or most of the mortgage amount from the sale of the property, PMI covers only a relatively small percentage of the loan. The percentage can range between 6% and 35% of the loan amount.
PMI is collected as part of your monthly mortgage payment. You’ve probably heard the term “PITI,” which refers to Principal, Interest, Taxes and Insurance; PMI is in the insurance part of the payment.
Understand however that PMI is not homeowners insurance. That’s a type of coverage that you are also required to have; that ensures the property against physical damage.
Another important factor is that FHA mortgages use an entirely different mortgage insurance scheme, that is known as mortgage insurance premium, or simply MIP. The FHA version does not change based upon your credit score.
It’s well known that credit scores have a major impact on the interest rates that will pay for any loan. That’s true of mortgages as well. Credit scores and interest rates have an inverse relationship. The higher your credit score is, the lower your interest rate will be, and vice versa.
That relationship also extends to PMI. Like all insurance policies, you pay a premium for PMI. That premium is based on a factor that changes with your credit score. It makes a major difference in the amount you will pay for your premium.
The best way to demonstrate how much your credit score will affect the PMI premium you will pay is by looking at some examples.
Let’s assume that you will be borrowing $200,000 for a 30-year fixed rate mortgage that represents 95% of the value of the home you are buying or refinancing. (This is referred to within the mortgage- and mortgage insurance-industries as “loan-to-value”, or “LTV”.)
The typical mortgage insurance requirement for a loan with these terms is 30%. That means that the mortgage insurance company will pay the lender up to 30% of your loan amount in the event that you default on your loan.
We’re going to use a PMI premium rate chart from MGIC, one the largest mortgage insurance companies in the country.
The line we want to pay attention to is the one that indicates an LTV of “95% – 90.01% on the far left. Then look at the top row in that block, where it indicates “30” in the “Coverage” column (starting with “.41”). The numbers in this row represent annual premium factors, and you’ll note that they increase as the credit score range decreases.
Your monthly mortgage insurance premium is determined by multiplying your mortgage amount by the annual premium factor, then dividing that number by 12. We can think of it as an equation that looks like this:
Loan Amount Credit Score Range Premium Factor Annual PMI Premium Divided by 12 Months Monthly PMI Premium
$200,000 760+ .41 $820 / 12 $68.33
$200,000 740 – 759 .59 $1,180 / 12 $98.33
$200,000 720 – 739 .73 $1,460 / 12 $121.67
$200,000 700 – 719 .87 $1,740 / 12 $145.00
$200,000 680 – 699 1.08 $2,160 / 12 $180.00
$200,000 660 – 679 1.42 $2,840 / 12 $236.67
$200,000 640 – 659 1.50 $3,000 / 12 $250.00
$200,000 620 – 639 1.61 $3,220 / 12 $268.33
700 – 719 is considered to be a good credit score range to be in. But notice that the monthly premium is $145.33, which is more than twice the $68.33 per month that applies for a credit score of 760 or higher.
And without even doing any heavy math, you can see the monthly PMI premium for the 620 – 639 credit score range is higher than the 760+ range by an incredible $200 per month. That means that your annual premium will be $2,400 higher if your credit score is at the lowest range, compared to the highest range.
That’s how your credit score affects the PMI premium you will pay.
Moral of the story: If you need a mortgage that will require PMI do everything that you can to improve your credit score before applying for the loan.