Private Mortgage Insurance for Jumbo Home Loans
Mortgage insurance, also known as private mortgage insurance (PMI), is an important consideration for jumbo home loans. Mortgage insurance protects your lender in case of default. While lenders are required by law to obtain mortgage insurance for most conventional loans, what about jumbo loans? We have the answers below.
Most homeowners know the importance of private mortgage insurance, PMI, when they have a small down payment.
Most homeowners know the importance of private mortgage insurance, PMI, when they have a small down payment. However, many people who have large down payments may not realize that they are still required to purchase PMI if their loan amount is above the conforming limit.
The basic concept behind PMI is simple: It protects your lender against losses caused by borrowers who default on their mortgages. If you don't make your payments for whatever reason (whether it's because of unemployment or some other financial emergency) and can't sell your house for enough money to pay off your outstanding mortgage balance, then the lender will lose money from not being able to recover its investment through foreclosure sales proceeds or sale-leaseback deals with third parties (which are typically more profitable).
If you need help figuring out how much private mortgage insurance cost per month depending on how much equity there is left after selling your home (or refinancing), check out our online calculator below!
The home loan industry has seen an uptick in jumbo loans lately
The term "jumbo" actually has nothing to do with location. Instead, it refers to the loan amount—a jumbo loan is one that's above the conventional loan limit set by the FHFA. The limit on your home loan depends on where you live and what type of property you want to buy.
Jumbo mortgages can vary from state to state—in some cases because there are multiple tiers of limits within each state's borders based on median incomes or property values. For example: In 2016, California raised its cap for jumbo loans from $417k up to $625k; New York State increased theirs from $1 million up to $1.25 million; while Texas' stayed put around $500k as long as the buyer doesn't own more than two properties at once (and they're not taking out another mortgage on top of that). Currently the conforming loan limit is $1,089,300 as of January 2023.
Why does a person need private mortgage insurance for a jumbo loan?
When you apply for a jumbo home loan, you'll be asked if you want to purchase private mortgage insurance. The lender is offering it because they want to protect themselves in case something unexpected happens with your loan. If they're not protected with PMI, they stand to lose money on your loan if the value of your home goes down enough that they can't sell it at auction.
The downside of having PMI is obvious: It's an extra monthly payment which reduces the amount of cash flow available each month, plus there are other expenses associated with buying and maintaining homeownership (insurance, property taxes). But private mortgage insurance can also have some benefits when considered alongside their costs.
It makes qualifying for jumbo loans easier than conventional ones—and most people who can afford jumbos need them because they have higher incomes or more assets than people who qualify for conventional loans.
It sounds counter-intuitive for someone who can afford a jumbo loan to have to shell out extra money for private mortgage insurance, but it's all about numbers.
You may be wondering why you have to pay for private mortgage insurance if you can afford the loan. The answer is that it all comes down to numbers.
The size of the loan depends on how much debt you want to take on and what kind of interest rates are available at that time. A jumbo mortgage typically requires more money than a traditional mortgage, but with larger loans come lower interest rates—so it's really all about whether you're willing to risk taking on more debt.
The value of your home will affect both how much insurance costs as well as what type.
What does PMI cover?
Private mortgage insurance protects the lender in case you default on your loan.
PMI is required for a loan that is more than 80% of the home's value or if you make less then a 20% down payment on a conventional loan. PMI must be paid by you as part of your monthly house payment.
PMI is calculated as a percentage of the loan amount. For example, if you take out a mortgage for $1 million and make an interest-only payment each month, your PMI can cost about $500 per month—or $6,000 annually—on top of your regular house payment.
Because of the way lenders assess risk, the value of your home matters more than the size of your loan in terms of whether you need PMI or not.
You may think that you have to have PMI when you get a jumbo home loan because the size of your loan is so large, but that's not true. Just like with conventional loans, lenders assess risk by looking at how much money you want to borrow, not how much equity you already have in your home.
Because of the way lenders assess risk, the value of your home matters more than the size of your loan in terms of whether or not you need PMI.
If a lender determines that they can't be sure it will be paid back if something goes wrong (for example, if there's a job loss), they'll charge PMI as protection against defaulting on the loan. This cost is typically added onto monthly payments until such time as enough payments have been made where they feel comfortable lending without it being necessary anymore (this process takes anywhere between five and 30 years).
That’s why you should always be careful when shopping for a jumbo loan. The amount you’re borrowing may not be as important as the value of your home, so make sure you know what type of mortgage will work best for you.