By Updated January 05, 2019
As a general rule, lenders like borrowers to provide a 20 percent down payment when getting a mortgage. If you’re looking for a mortgage loan with a smaller down payment, your lender will require you to carry private mortgage insurance (PMI) on your loan. How much you pay for this insurance and how long you carry it both vary based on several factors, including your lender’s rules, your credit score and what kind of property you’re buying, among other things.
As of 2018, the average cost of PMI is between 0.3 and 1.2 percent of your entire loan amount each year.
Know PMI Cost Basics
On average, Americans pay 0.3 to 1.2 percent of their mortgage loan amount each year for PMI. In 2018, the median price of a U.S. home was $261,500. If you take out a mortgage for this amount with a PMI premium of 1 percent per year, you’ll pay $2,615 a year for PMI. If paid monthly, that premium would add about $218 to your mortgage payment each month.
How long you need to carry PMI varies. With a conventional mortgage loan, you’ll have to keep paying your PMI until you reach a loan-to-value (LTV) ratio of 80 percent. At that LTV, you have 20 percent equity in your home. Veteran Affairs (VA) loans may not require any mortgage insurance, while Fannie Mae and Freddie Mac require borrowers to pay mortgage insurance for two to five years.
Understand That MIP Is Different
FHA loans charge borrowers mortgage insurance premiums (MIP) rather than PMI. With MIP, borrowers must pay 1.75 percent of the borrowed amount upfront and then continue to pay MIP every month. FHA MIP rates range from 0.45 to 1.05 percent of your total mortgage amount every year. Depending on when you took out your loan and how much you put down, FHA MIP premiums may last for 11 years or for the life of your loan.
With permanent MIP, a $300,000 mortgage with a .8 percent MIP rate results in MIP payments of $2,400 per year. Over 30 years, this adds up to a jaw-dropping $72,000 of mortgage insurance premiums. It’s easy to see why most FHA borrowers refinance into a conventional mortgage without MIP or PMI as soon as they can.
Know the Loan-to-Value Ratio
Lenders calculate your LTV ratio by dividing the amount of your mortgage by the assessed value of your home. This value calculates what percentage of the home’s value you’re borrowing. The higher the number, the higher the risk to your lender. When your LTV ratio goes up, so does the cost of your PMI. How much it goes up varies by lender. An LTV ratio under 85 could result in a PMI rate of 0.75 percent while an 88 percent LTV ratio could generate a 1.38 percent insurance premium.
Consider Your Credit Score
The lower your credit score, the more likely lenders feel you may default. As such, PMI premiums increase as a borrower’s credit score decreases. Even if everything else about them is the same, a borrower with a credit score of 780 or better may enjoy a PMI premium of 0.3 percent while a borrower with a credit score of 630 may have to pay 1.2 percent. Borrowers with a low credit score can sometimes combat higher PMI premiums by putting down a large downpayment. Ideally, these borrowers would do best to put down 20 percent and avoid PMI altogether.
Evaluate Other Factors and Adjustments
Your mortgage lender may use additional criteria to determine your PMI rates. Lenders often charge borrowers higher insurance rates when they’re buying a second home or an investment property. You can lower the PMI on a multiple-dwelling unit if you plan to live there in addition to tenants. Because they sometimes depreciate, borrowers buying a manufactured home may have to pay a higher PMI rate. Longer loan terms, too, generally invite higher PMI. Location is also a factor. In areas like San Francisco where property values are steadily rising, lenders may offer lower PMI rates. It may also take buyers less time to reach the desired 80 percent LTV ratio.