PMI: How private mortgage insurance works and why it can benefit homebuyers

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Private mortgage insurance, also known as PMI, is generally required when you purchase a home with less than 20 percent down. The extra charge helps offset the risk to your lender, and it’s especially common for government-backed loans, such as FHA and USDA mortgages, which typically allow minimal down payments.

In most cases, you need to make an upfront payment for your PMI at closing then additional monthly payments on top of payments towards your mortgage.

What is PMI?

Private mortgage insurance or PMI is a type of insurance that conventional mortgage lenders require when homebuyers put down less than 20 percent of the home’s purchase price. Borrowers with PMI pay a mortgage insurance premium, and costs vary by lender.

The insurance protects lenders in case the homeowner defaults on the loan. While it doesn’t protect the buyer from foreclosure, it does allow prospective homebuyers to become homeowners, even if they can’t afford a 20 percent down payment. If your lender determines that you’ll need to pay PMI, it will coordinate with a private insurance provider, and the terms of the insurance plan will be provided to you before you close on your mortgage.

When you have PMI, you’ll need to pay an extra fee every month in addition to your mortgage principal, interest, property taxes and homeowners insurance. Your loan documents may also indicate when you’ll be able to stop paying PMI, usually when you build up equity equal to at least 20 percent of your home’s value. This means the remaining balance of your loan is 80 percent or less of your home’s total value.

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 80 percent of the home’s original value.

How much does PMI cost?

According to the Urban Institute, the average range for PMI premium rates was 0.58 to 1.86 percent as of November 2020. Freddie Mac estimates most borrowers will pay $30 to $70 per month in PMI premiums for every $100,000 borrowed.

Your credit score and loan-to-value (LTV) ratio have a big influence on your PMI premiums. The higher your credit score, the lower your PMI rate typically is. A high LTV will also generally make your PMI payments more expensive.

A quick primer on LTV if you’re not familiar: The ratio is essentially how much you’re borrowing compared to the total value of the asset you’re purchasing — in this case, a house. Basically, the more you put down, the less you have to borrow, so the lower your LTV will be. If you put down 20 percent, your LTV is 80, and you won’t need to pay for PMI. Anything less, and you probably will be required to get the insurance. The less you put down, the more insurance you’ll need to pay.

Here’s how it might play out:

Example with PMI

Sources: Bankrate mortgage calculator, Freddie Mac mortgage insurance calculator
Home price $300,000
Down payment $30,000 (10%)
Interest rate 3%
PMI (per month) $176
Monthly payment (principal, interest and PMI) $1,314

Example without PMI

Source: Bankrate mortgage calculator
Home price $300,000
Down payment $60,000 (20%)
Interest rate 3%
Monthly payment (principal and interest, no PMI) $1,011

How do I make PMI payments?

PMI payment options differ by lenders, but typically borrowers can opt to make a lump-sum payment each year or pay in monthly installments.

Usually, borrowers couple the cost of the premium with their monthly mortgage payment, so they pay an extra fee every month. With this method, you’ll be able to find a full breakdown of the costs in your loan estimate and closing disclosure documents.

Some borrowers choose lump sum or “single-payment” mortgage insurance, instead, meaning they pay the full annual cost of their PMI upfront. The lump sum option is probably not a good idea if you’re thinking of moving or refinancing your mortgage, because the payment is not always refundable, even if you no longer hold the mortgage it was applied to.

The third option is a hybrid which allows you to make a partial upfront payment and roll the rest into your monthly mortgage bill. Your lender should tell you the amount of the upfront premium, then how much will be added to your monthly mortgage payment.

Ask your lender if you have a choice for your payment plan, and decide which option is best for you.

Do all lenders require PMI?

As a rule, most lenders require PMI for conventional mortgages with a down payment less than 20 percent. However, there are exceptions to the rule, so you should research your options if you want to avoid PMI.

For example, there are low down-payment, PMI-free conventional loans, such as PMI Advantage from Quicken Loans. The lender will waive PMI for borrowers with less than 20 percent down, but also bump up your interest rate, so you need to do the math to determine if this kind of loan makes sense for you.

If you’re eligible, VA loans don’t require PMI, which is helpful for homebuyers who don’t have enough saved up to make a large down payment.

Other government-backed loan programs like Federal Housing Administration (FHA) loans require their own mortgage insurance, though the rates can be lower than PMI. In addition, you won’t have an option to cancel the insurance even after you reach the right equity threshold, so in the long term, this can be a more expensive option. Your credit score won’t affect the insurance rate for FHA loans, though it could be higher if you put down less than 5 percent.

Is there any advantage to paying PMI?

PMI is a layer of protection for lenders, but an added expense for you as a borrower. However, that doesn’t mean it’s all downside for homebuyers. PMI might allow you to purchase a home sooner because you won’t have to wait to save up for a 20 percent down payment. If your credit score is high and your LTV is relatively low, you should be able to get a low PMI rate, which will make your mortgage more affordable overall.

In some cases, paying PMI can even help you build wealth faster. Homeownership is usually seen as an effective long-term wealth building tool, so owning your own property as soon as possible lets you start building equity sooner, and your net worth will expand as home prices rise. If home prices in your area rise at a percentage that’s higher than what you’re paying for PMI, then your monthly premiums are helping you get a positive ROI on your home purchase.

Note that PMI is also deductible for tax years 2018 and 2019 (retroactive) and 2020.

How do I avoid private mortgage insurance?

  1. 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.
  2. Consider a government-insured loan. 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. VA and USDA loans do not require mortgage insurance. FHA loans, however, do come with two types of mortgage insurance premiums: one paid upfront and another paid annually.
  3. 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 insurance premiums.

Bottom line

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 will help you reach your real estate goals faster. Don’t agree to a mortgage without comparing offers from at least three different lenders, though — that way you can try to get the best rate and terms for your specific financial situation.

With additional reporting by Sarah Li Cain

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