What is private mortgage insurance (PMI)?
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When you buy a home, you often take out homeowners’ insurance to protect the property. However, you might also be on the hook for another kind of insurance coverage — one that doesn’t protect you, but instead protects the lender.
It’s called private mortgage insurance (PMI) and it’s a common cost for mortgage borrowers who make less than the standard down payment of 20 percent of the home’s purchase price.
Here’s a guide to how it works, how much it is and how long you have to pay it.
What is PMI?
Private mortgage insurance (PMI) is a type of surcharge that conventional mortgage lenders impose when homebuyers finance more than 80 percent of the property’s cost.
PMI is designed to protect the lender in the event that the homeowner defaults on the loan. While it doesn’t protect the homeowner 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 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.
If you’re paying for PMI, that cost won’t stay with you forever. 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 loan servicer about removing PMI from your mortgage.
By law, lenders must terminate PMI on the date that your loan-to-value ratio (LTV) is scheduled to reach 78 percent: that is, the outstanding balance on your mortgage is down to 78 percent of the home’s original worth/purchase price, and you own 22 percent of the home outright.
How much does PMI cost?
The average range for PMI premium rates is 0.58 percent to 1.86 percent of the original amount of your loan, according to the Urban Institute. Freddie Mac estimates most borrowers will pay $30 to $70 per month in PMI premiums for every $100,000 borrowed.
Here’s a look at how PMI might play out based on how much you put down, according to the Freddie Mac mortgage insurance calculator and the Bankrate mortgage calculator. These examples assume a $329,000 home purchase price and a 6.89 percent interest rate. Note: the monthly mortgage payments in this table don’t include homeowners insurance and property taxes.
|Down payment||5% down||15% down||20% down|
|Monthly PMI payment||$300||$78||$0|
|Monthly mortgage payment (principal, interest and PMI)||$2,639||$2,200||$2,014|
Factors that influence the cost of PMI
- Your loan-to-value (LTV) ratio – How big a percentage of the home’s purchase price you’re financing, the LTV ratio, will impact how much you’ll pay for PMI. When you can only put up a small amount of cash, the lender is assuming a bigger risk, and your PMI payments will be higher to account for that risk. A loan-to-value calculator can help you derive your LTV ratio.
- Your credit score – Your credit history and corresponding credit score play a major role in the cost of PMI. For example, consider the Urban Institute’s example of someone buying a $275,000 property with a 3.5 percent down payment. With an excellent FICO score of 760 or greater, the monthly mortgage payment including the insurance is $1,241. For a buyer with a mediocre credit score between 620 and 640, those monthly payments are $1,604 – a reflection of a significantly higher PMI charge.
- Your loan type – Because adjustable-rate mortgages (ARMs) carry a higher risk for lenders, your PMI may be more expensive with an ARM than it might be with a fixed-rate mortgage loan.
Different types of private mortgage insurance
There are several kinds of private mortgage insurance.
With borrower-paid mortgage insurance, the premiums are part of your monthly bill. This will also include the principal balance, interest charges and other costs such as property taxes. The funds are then disbursed each month to the insurer.
You’ll see an indication each month of a “special payment,” which is simply an explanation that the money was paid out.
With borrower-paid mortgage insurance, you may be able to get the payments removed after meeting specific requirements, such as reaching 20 percent equity, 78 percent loan-to-value, or finishing half of your payment term.
Lender-paid mortgage insurance might sound appealing, but make no mistake: You’ll still pay for the coverage. Instead of seeing that premium as a line item, you’ll likely pay a higher interest rate on the mortgage and/or shell out additional origination fees for the loan.
Another drawback is that you can’t get lender-paid PMI canceled in the same way that you can with borrower-paid insurance. Your main path to getting out of lender-paid PMI is to refinance.
Instead of dividing up payments into regular installments each month, single-premium PMI bundles the entire cost of the premiums into one lump payment. Depending on the terms of the loan, you can either pay this in full at closing or roll the amount into the loan for a higher balance.
If you pay it upfront, you’ll get the benefit of lower monthly mortgage payments. However, if you sell your home shortly after buying it, you might wind up worse off: You basically paid premiums in advance for nothing.
Also if you’re struggling to make a 20 percent down payment, you may not have the cash to afford an upfront insurance payment, which can be several thousands.
In a split-premium PMI arrangement, you’ll pay a larger upfront fee that covers part of the costs to then shrink your monthly payment obligations.
This combines the pros and cons of single-premium and borrower-paid PMI. You need some cash, but not as much, to pay the upfront premium. You then benefit from lower monthly costs.
Split-premium mortgage insurance can also be helpful if you have a debt-to-income ratio (DTI) that’s on the high side. It lets you lower your potential mortgage payment to avoid pushing your DTI too high to qualify for the loan.
FHA mortgage insurance
FHA loans require their own form of mortgage insurance, a sort of government equivalent to PMI. FHA mortgage insurance involves an upfront payment and annual mortgage insurance premiums (MIP), which in most cases cannot be canceled, even after you reach the right equity threshold.
While MIP rates are slightly less expensive than PMI (and less affected by your credit score), MIP can be a more expensive option — because in most cases, you’re stuck paying it for the lifetime of the loan; there’s now no automatic cancellation even after you reach the magic 78 percent LTV threshold (except for loans that originated in 2001-13).
For loans issued after 2013, there is one way out: The MIP will be canceled after 11 years, if you made a down payment of at least 10 percent. Otherwise, your main option to get rid of MIP is to refinance the FHA loan into a conventional mortgage.
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.
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.
Some government-backed programs don’t charge mortgage insurance. For example, VA loans don’t require it (but of course you have to be current or ex-military to be eligible).
Is there any advantage to paying PMI?
Paying PMI comes with one major benefit: It enables you to buy a home without waiting to save up for a 20 percent down payment. Single-family home prices remain high, sitting at a median price point of $375,700 in March 2023, according to the National Association of Realtors. A 20 percent down payment at that price would be more than $75,000, which can seem like an impossible figure for many first-time homebuyers.
Homeownership is generally an effective long-term wealth-building tool, so owning your own property sooner rather than later allows you to start building equity, 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 — irritating as they are — are helping you get a positive return on your investment on your home purchase.
How do I make PMI payments?
There are three primary schedules for making PMI payments. The options available to you will vary depending on your lender.
- Monthly: The most common method is paying PMI premiums monthly with your mortgage payment. This boosts the size of your monthly bill, but allows you to spread out the premiums over the course of the year.
- Upfront: Another option is an upfront PMI payment, meaning you pay the full premium amount for the year all at once. Your monthly mortgage payment will be lower, but you need to be ready for that larger annual expense. Additionally, if you move sometime in the year, you might not be able to get part of your PMI refunded.
- Hybrid: The third option is a hybrid one: paying some upfront and some each month. This can be useful if you have extra cash early in the year and want to limit your monthly housing costs.
How to avoid paying PMI?
To avoid PMI for most loans, you’ll need at least 20 percent of the home’s purchase price set aside for a down payment. For example, if you’re buying a home for $250,000, you need to be able to put down $50,000.
Another strategy is a piggyback mortgage. With a piggyback loan, you’d actually get two separate mortgages, one for 80 percent of the home’s value and one for 10 percent. You’d make a 10 percent down payment from your savings, and use the smaller of the two loans to complete the 20 percent down payment.
The upside of this strategy is avoiding PMI, but a piggyback mortgage means having two loans and two monthly payments to make, so consider this option carefully. Some piggyback loans also have shorter terms than the primary mortgage, so your monthly payments will be higher.
You can also find a lender that offers lender-paid PMI. In this scenario, the lender will make the PMI payments. However, the loans usually have higher interest rates.
Another option is to look for loans with no PMI requirements. Some loan programs, such as VA loans, have no PMI payments. Individual lenders may also offer mortgage programs that let you avoid PMI, such as programs for low-income buyers, or people in specific professions such as teaching or medicine.
FAQs on private mortgage insurance
Yes, you can deduct PMI, but the benefit begins to phase out after your adjusted gross income reaches $109,000. You should determine if itemizing your deductions and including your PMI is greater than taking the standard deduction.
Homeowners typically pay PMI until they have reached 20 percent equity in their home, or an 80 percent or smaller loan-to-value (LTV) ratio on their mortgage. Loan servicers must terminate PMI once you reach a 78 percent LTV ratio, based on the home’s original assessed value.
PMI protects a mortgage lender against the risk that a borrower will default on their loan. Mortgage protection insurance (MPI) protects the borrower by covering mortgage payments for a period of time if you become disabled or lose your job. MPI can also pay your mortgage off in the event of your death.