Private mortgage insurance (PMI)

Private mortgage insurance is a money term you need to know. Bankrate explains.

What is private mortgage insurance?

Private mortgage insurance is what borrowers have to pay when they take out a mortgage from a commercial lender and pay a down payment of 20 percent or less. PMI insures the mortgage for the lender in the event that the borrower defaults. Although PMI usually costs between 0.5 and 1 percent, it can add up to thousands of dollars.

Deeper definition

People who take out mortgages generally have to pay mortgage insurance if they pay a down payment less than 20 percent of the mortgage amount. That’s because they’re considered higher risk than those who can afford higher down payments.

Such loans for high-risk people are often backed by government agencies like the Federal Housing Administration. However, when the borrower receives a mortgage through a commercial lender, she pays her the mortgage insurance premium directly to the lender in what’s called private mortgage insurance.

The cost of PMI depends on the borrower’s financial background, like her credit score, income, and the amount of her mortgage. PMI costs between 0.5 percent and 1 percent of the original loan amount. The borrower may pay her premium monthly as bundled with her regular mortgage payment or may have the option of paying it all in a lump sum.

All types of mortgage insurance must end after the home accrues equity of 20 percent or when the principal reaches 78 percent of the original amount. For the former case, the borrower may have to request the discontinuation in writing, but in the latter it should be automatic.

Want to know how long it’ll be before you pay off your principal? Use our mortgage calculators to find out.

Private mortgage insurance example

Martin was approved for a loan with a down payment of 15 percent. Although this lets him move into a home sooner for less money, his bank asks him to pay PMI of about 0.75 percent of the original loan amount. That ends up costing him an additional $90 per month, or $1,080 per year, on top of his interest and principal payments.

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