PMI: What Private Mortgage Insurance Is And How To Avoid It

PMI: What Private Mortgage Insurance Is And How To Avoid It

Private mortgage insurance is what homeowners will need to pay to offset the risk to the lenders who grant you a home loan — it’s typically required for government-backed loans such as FHA and USDA loans. In most cases you may need to make an upfront payment at closing then additional monthly payments on top of payments towards your mortgage.

Private mortgage insurance, or PMI is a type of mortgage insurance for conventional loans and arranged with a private company. It can increase the cost of your loan and is typically included in your total monthly payment.

What is PMI?

This is a type of insurance conventional mortgage lenders require when homebuyers put down less than 20 percent of the home’s purchase price. You’ll need a pay a mortgage insurance premium — the amount to receive PMI — though how you do so can differ by lender.

Essentially, PMI insurance protects lenders in case the homeowner defaults on the loan since the homeowner has less than 20 percent equity stake in the house. PMI doesn’t necessarily protect the buyer, but it does offer a way for you to become a homeowner if you don’t have at least 20 percent for a down payment.

If your lender determines that you’ll need to pay PMI, it’ll arrange it through a private insurance provider. Before you close on the loan, you will know how much 

PMI you’ll need to pay in addition to your mortgage principal, interest and taxes. Your loan documents many also indicate when you’ll be able to stop paying PMI — basically when your loan reaches 80 percent of your home’s value.

How much does PMI cost?

The average annual PMI premium typically ranges from .55 percent to 2.25 percent of the original loan amount each year, according to data from Ginnie Mae and the Urban Institute. With these rates, it means that for a $200,000 mortgage, your PMI can cost between $1,100 and $4,500 each year, or around $91.66 to $375 per month.

Your credit score and loan-to-value (LTV) ratio have a big influence on your PMI mortgage premiums. For example, the higher your credit score, the lower your PMI rate can be. Whereas the higher your LTV, you could find yourself with a higher you PMI bill.

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See below for a comparison of costs between two scenarios. The house price and interest rate are the same, but the down payment is lower 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 do 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. Once you make this payment, you may not be able to get a refund of your premium if you decide to refinance or move homes.

More commonly, borrowers roll the full premium into their monthly mortgage payment. You’ll be able to find a full breakdown in your loan estimate and closing disclosure documents.

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.

It’s worth asking your lender if you have a choice in any of the above options — work with your loan officer to calculate total costs to see what may the most cost effective choice

It’s also 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 mortgages with a down payment less than 20 percent. However, there are exceptions to the rule — 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. This lender will waive PMI for borrowers with less than 20 percent down but they’ll bump up your interest rate. Do the math to figure out if this product makes sense.

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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. However, loan and income limits may apply so not everyone may qualify.

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

Other government backed loan programs like the Federal Housing Administration (FHA) loans require mortgage insurance, though the rates can be lower than PMI. In addition, you won’t have an option to cancel the loan, no matter your LTV, which can make it the more expensive option. Your credit score won’t affect the rate, though it could be higher if you put less than five percent as your down payment.

Best practices to implement before you choose a lender

  1. Shop around. Don’t agree to a mortgage without comparing offers from at least three different lenders. That way you can try to get the best rates and terms for your specific financial situation.
  2. Bump up your down payment. If you can spend a little extra time saving for a minimum of a 20 percent 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.
  3. 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.

Is there any advantage to paying PMI?

PMI is a layer of protection for lenders, but an added expense for you as a borrower. Conventional loans — loans not backed by the federal government — are the most popular type of mortgages.

However, it does offer you the opportunity to purchase a home sooner instead of having to wait until you have 20 percent down. If your credit score is high and your LTV is relatively low, you may be able to get a low PMI rate, which can make your overall mortgage more affordable.

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In some cases, paying PMI can help you build wealth faster. Assuming homeownership is an effective long-term wealth building tool, getting a mortgage sooner than later can help you take advantage of future rising home prices.

If home appreciation rises at a percentage that’s higher than what you’re paying for PMI (which goes down the longer you keep your mortgage), then your monthly premiums are helping you get a positive ROI on your home purchase.

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.

While some lenders require PMI for conventional loans with lower down payments, others don’t but may charge a higher interest rate.

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. 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.
  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 mortgage insurance premiums.

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.

With additional reporting by Sarah Li Cain.

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