PMI is short for private mortgage insurance. This is a type of insurance mortgage lenders require when homebuyers put down less than 20 percent of the home’s purchase price.
Essentially, PMI protects lenders in case the homeowner defaults on the loan. Since the homeowner has less than 20 percent equity stake in the house, PMI helps offset the lender’s risk. PMI doesn’t protect the buyer, but it does offer a way to become a homeowner if you don’t have at least 20 percent for the down payment.
How much does PMI cost?
PMI can be a significant expense. 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 Ginnie Mae and the Urban Institute.
Your credit score and loan-to-value ratio have a big influence on your PMI premium. 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.
See the table below for a comparison of costs between two scenarios where house price and interest rate are the same, but down payment varies, triggering PMI in example B.
Example A: Without PMI
House cost $200,000
Down payment: $40,000 (20% of cost)
Interest rate: 4%
Monthly payment (principal and interest monthly): $763
Example B: With PMI
House cost $200,000
Down payment: $20,000 (10% of cost)
Interest rate: 4%
PMI: $166 (1% of home cost)
Monthly payment (principal, interest and PMI): $1,025
How can I make PMI payments?
PMI payment options differ by lenders, but typically borrowers can opt to make a lump sum payment each year, which is known as single-payment mortgage insurance.
Commonly, however borrowers roll the full premium into their mortgage payment. The third option is a hybrid which allows you to make a partial upfront payment and roll the rest into your monthly mortgage bill.
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.
Do all lenders require PMI?
As a rule, most lenders require PMI for conventional loans with a down payment less than 20 percent. However, there are exceptions to the rule, so if you want to sidestep PMI, research your options.
There are banks that offer low down-payment, PMI-free conventional loans, such as PMI Advantage from Quicken Loans. Quicken Loans will waive PMI for borrowers with less than 20 percent down, however in exchange they’ll bump up your interest rate. In this case, you have to do the math to figure out if this product makes sense.
Bank of America also offers a product called the Affordable Loan Solution for low-income borrowers with as little as a 3 percent down payment and no PMI requirements.
If you’re eligible, VA loans don’t require PMI, which is helpful for homebuyers who don’t have a large down payment.
Before you choose a lender:
- 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.
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.