When you buy a home, a 20 percent down payment is recommended. While it’s not wrong to have a smaller down payment — you’ll still be able to buy a home — it does have some drawbacks. The biggest is the need for costly private mortgage insurance, or PMI.
What is private mortgage insurance?
Private mortgage insurance is a type of insurance you may be required to pay for when you take out a conventional home loan.
If you’re buying a home, lenders require PMI as part of a conventional loan to protect them in case you end up in foreclosure. The insurance protects the lender for at least some of the shortfall if the home is sold in foreclosure for less than the outstanding amount of the mortgage. PMI is generally required if you refinance your mortgage with less than 20 percent equity.
The good news is that having PMI can help you qualify for a mortgage if you otherwise couldn’t — especially if you don’t have a 20 percent down payment. But not everyone can get a conventional loan; many lenders require higher credit scores to get approved.
Should you avoid PMI?
PMI is a layer of protection for lenders, but an added expense for you as a borrower. Conventional loans, which are any loans not backed by the federal government, are the most popular type of mortgages.
Once you’ve reached 20 percent equity — either through paying down your loan balance over time or through rising home values — you can contact your lender (in writing) about removing PMI from your mortgage. Loan servicers must terminate PMI on the date that your loan balance is scheduled to reach 78 percent of the home’s original value, according to the Consumer Financial Protection Bureau.
While some lenders require PMI for conventional loans with lower down payments, others don’t but may charge a higher interest rate.
Here are a few ways to avoid private mortgage insurance:
- Put 20 percent down. The higher the down payment, the better. At least a 20 percent down payment is ideal if you have a conventional loan.
- Consider a government-insured loan. Loans backed by the U.S. Department of Veterans Affairs and the U.S. Department of Agriculture do not require mortgage insurance. FHA loans, however, do come with two types of mortgage insurance premiums — one paid upfront and another paid annually.
- Cancel PMI later. If you already have PMI, keep track of your loan balance and area home prices. Once the loan balance reaches 80 percent of the home’s original value, you can ask the lender to drop the mortgage insurance premiums.
- Learn about other ways to get rid of PMI.
How much does PMI cost?
The average annual PMI premium typically ranges from .55 percent to 2.25 percent of the original loan amount per year, according to data from Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute. Your credit score and loan-to-value ratio will impact the specific premium you’re charged. For example, if the home price is $200,000 and your PMI is 1 percent, you’ll pay $2,000 a year, or a bit more than $166 a month.
There are a few different ways to pay for PMI, including:
- Monthly. Most PMI policies require you to make monthly payments. This is an additional charge added onto your monthly mortgage payment.
- An up-front payment. Sometimes, lenders require PMI to be paid in full at closing. This will be outlined in your loan estimate.
- Both. Some lenders might let you pay a portion of your PMI upfront and the rest in your monthly mortgage payment.
It’s worth noting that mortgage insurance premium payments used to be tax-deductible. Under the new tax law, though, the deduction expired at the end of 2017.
How do you know if you should get PMI?
Getting private mortgage insurance is typical for conventional loans with lower down payments, but you might not need it. Make sure you’re considering all of your options before agreeing to a loan with PMI.
Some factors include:
- Shop around. If you settle for the first lender that pre-approves you for a mortgage, you might end up paying more in interest and mortgage insurance. Don’t agree to a mortgage without comparing offers from at least three different lenders.
- Bump up your down payment. Remember that 20 percent avoids PMI. If you can spend a little extra time saving for a higher down payment, you’ll be able to lower your monthly payments in the long run. Buying a less expensive house is another option to avoid PMI.
- Consider other types of loans. While conventional loans are the most popular type of home financing, they’re just one of many options. Look at FHA, VA and other types of home loans to make sure you’re getting the right one for your situation.
Private mortgage insurance adds to your monthly mortgage expenses, but it can help you get your foot in the homeownership door. When you’re buying a home, check to see if PMI makes sense.
This article has been updated to include correct average PMI costs, the loss of tax deductibility of mortgage insurance under the new tax law and that loan servicers are required to terminate PMI automatically once a loan’s principal balance is scheduled to reach 78 percent of the property’s original value.