Guide to Understanding Private Mortgage Insurance (That’s PMI)
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If you’ve ever purchased a home without a large down payment, you may have faced the possibility of paying PMI, or private mortgage insurance. This financial product is a type of loan insurance typically bought by consumers when they purchase a house. However, the premiums paid toward PMI aren’t intended to protect the consumer. Rather, they provide protection for the lender, in case you stop making payments on your home loan.
As the Consumer Financial Protection Bureau (CFPB) notes, PMI is typically arranged by your lender during the home loan process and comes into play when you have a conventional loan and put down less than 20 percent of the property’s purchase price. However, private mortgage insurance is not just associated with home purchases; it can also be required when a consumer refinances his or her home and has less than 20 percent equity in it.
Generally speaking, PMI can be paid in three different ways — as a monthly premium, a one-time upfront premium or a mix of monthly premiums with an upfront fee.
There are also ways to avoid paying PMI altogether, which we’ll address later in this guide.
While PMI is private mortgage insurance consumers buy to insure their conventional home loans, the similarly named MIP – that’s mortgage insurance premium — is mortgage insurance you buy when you take out an FHA home loan.
MIP works kind of like PMI, in that it’s required for FHA (Federal Housing Administration) loans with a down payment of less than 20 percent of the purchase price. With MIP, you pay both an upfront assessment at the time of closing and an annual premium that is calculated every year and paid within your monthly mortgage premiums.
Generally speaking, the upfront component of MIP is equal to 1.75 percent of the base loan amount. The annual MIP premiums, on the other hand, are based on the amount of money you owe each year.
The biggest difference between PMI and MIP is this: PMI can be canceled after a homeowner achieves at least 20 percent equity in his/her property, whereas homeowners paying MIP in conjunction with a FHA loan that originated after June 13, 2013, cannot cancel this coverage until their mortgage is paid in full. You can also get out from under MIP by refinancing your FHA loan into a new, conventional loan. However, you’ll need to leave at least 20 percent equity in your home to avoid having to pay private mortgage insurance on the refi.
If you’re thinking of buying a home and wondering if you’ll be on the hook for PMI or MIP, it’s important to understand different scenarios in which these extra charges may apply.
Here are the two main loan situations where you’ll absolutely need to pay mortgage insurance:
- FHA loans with less than 20 percent down – If you’re taking out a FHA loan to purchase a home, you may only be required to come up with a 3.5 percent down payment. You will, however, be required to pay both upfront and annual mortgage insurance premium (MIP).
- Conventional loans with less than 20 percent down – If you’re taking out a conventional home loan and have less than 20 percent of the home’s purchase price to put down, you’ll need to pay PMI.
Before you can decide whether paying PMI is worth it in order to buy the home you want, it’s important to understand just how much this insurance will set you back. Unfortunately, the answer isn’t always cut and dried.
According to Patrick Morgan, a longtime mortgage broker and owner of Greenside Properties California, PMI can vary quite a bit, depending on factors such as your credit score, the percentage of your down payment, the total loan amount, the term of the loan and the type of mortgage chosen.
Generally speaking, however, PMI typically works out to roughly 0.15 to 1.95 percent of the loan amount each year, he says.
Here’s a good example of how this might work:
Let’s say a borrower, Mrs. Jones of Iowa, makes an offer on a home for $250,000. She doesn’t have enough saved to put down 20 percent of the purchase price, but she is able to come up with a 10 percent down payment of $25,000.
After putting down 10 percent of the cost of the home, Mrs. Jones is left borrowing $225,000 over 30 years, with an interest rate of 3.75 percent.
With a 30-year mortgage, the principal and interest payment on her loan would be about $1,042 per month. However, Mrs. Jones would need to pay PMI, or private mortgage insurance of 0.15 to 1.95 percent of her home loan until she reached 20 percent equity and was able to get PMI cancelled.
As a result, her PMI premium could range from $337.50 annually ($28.13 per month) to $4,387.50 annually ($365.63 per month).
Since PMI is intended to protect your lender in the event you default on your loan, it doesn’t come with any tangible benefit to the borrower. Still, that doesn’t mean paying PMI is always a lost cause.
The biggest benefit of PMI is that it can help you qualify for a home loan you could not get under other circumstances. The truth is, as great as it sounds to save up 20 percent of a home purchase before you buy, this isn’t always possible.
Sometimes, buyers decide it’s more important for them to purchase a home and start building equity than it is to save up 20 percent and avoid PMI.
Fortunately, PMI can be canceled later on, once the homeowner has built up enough equity.
More on that in a minute, but first, let’s take a look at how a mortgage payment could look with and without a 20 percent down payment and/or PMI:
Once again, we’ll use Mrs. Jones and her $250,000 home as an example.
|5% down payment||10% down payment||20% down payment|
|Mortgage type||30-year fixed||30-year fixed||30-year fixed|
|Monthly mortgage payment (Principal and Interest)||$1,100||$1,042||$926|
|PMI* (rounded off)||$198||$188||$0|
|Total monthly mortgage payment||$1,298**||$1,230**||$926**|
*Assuming an insurance rate of 1 percent
**Amount doesn’t include property taxes or insurance
According to the CFPB, PMI isn’t always paid in a monthly premium as illustrated in the table above. In fact, there are actually three different ways you can pay for this insurance coverage:
#1: Pay PMI with a monthly premium.
The most common way to pay your PMI premium is with that monthly premium. In this case, notes the CFPB, the premium is added to your monthly mortgage payment and is shown on your loan estimate and closing disclosure statement.
#2: Pay PMI with a one-time, upfront premium at closing.
The CFPB also notes that lenders will occasionally offer the option of letting you pay all your PMI premiums upfront at closing. This premium is once again shown on your loan estimate and closing disclosure within your mortgage paperwork.
The downside of this option is that if you move or refinance, you may not have your upfront PMI refunded. Morgan says paying PMI upfront used to be popular but is rarely available any longer.
#3: You may be asked to pay both an upfront PMI payment and monthly premiums.
Both the upfront premium and the monthly premium added to your mortgage payment are shown on your loan estimate and closing disclosure within your mortgage paperwork with this option, notes the CFPB. The benefit of this option, notes Morgan, is the fact you can get some of your PMI payment out of the way and enjoy lower monthly payments thereafter.
Generally speaking, notes Morgan, how a buyer pays PMI is entirely up to them. When they sit down with a mortgage lender, each of these options may be discussed and available to them. However, it’s never guaranteed that all lenders will let you pay PMI upfront since this option is not used frequently anymore.
Only you can decide whether you think paying PMI is worth getting into the home you want. However, there are several ways to avoid this charge.
Before you blindly pay PMI, you should consider the alternatives and what they might mean for you as a homeowner. Here are three ways to avoid PMI completely:
The best way to avoid PMI completely is to save up at least 20 percent of your future home loan before you buy. By putting down 20 percent of your home’s value upon purchase, there’s no PMI to pay. Simple.
Pros of saving up 20 percent or more:
- You won’t have to pay PMI or cancel it later on. If you save up 20 percent before you purchase a home, you will never have to pay PMI or go through the hassle and stress of getting it canceled later on.
- You’ll have considerable home equity from Day 1. By saving up a beefier down payment, you’ll have considerable equity in your home from your first day as a homeowner. This reduces the risk of you becoming “underwater” on your loan — or owing more than your home is worth.
- You may qualify for better interest rates or loan terms. A larger down payment usually means less risk for the lender. In turn, it may be inclined to offer superior rates and terms.
- Your monthly payment will be lower. This is basic math: The larger your down payment, the lower your monthly mortgage payment.
Cons of saving up 20 percent or more:
- It will take longer to get into the home you want. This is also basic mathematics: The more money you have to save, the longer it usually takes. Saving up 20 percent of your home purchase could take years or longer, depending on your spending and saving practices and habits.
- Home prices may go up while you’re saving cash. If it takes you years to save up 20 percent to buy a home, you may face huge price increases in housing in the meantime. These price increases could wipe out whatever you save by avoiding PMI.
- Interest rates may rise while you wait. While interest rates are still near records lows right now, they may not stay this way forever. If it takes you years to save up 20 percent and you pay a higher interest rate as a result, any savings resulting from avoiding PMI may be negligible or nonexistent due to higher interest costs.
Who is this option best for?
- Saving up 20 percent of a home purchase may sound like an impossible feat, but this strategy can work for people with high savings rates or those who live in an area with low-cost housing.
A piggyback second mortgage can help you avoid PMI. If you choose this option, you’ll take out a conventional first mortgage and a “piggyback” second mortgage that comes in the form of a home equity loan or home equity line of credit.
This strategy lets borrowers with a down payment of less than 20 percent purchase a home without paying PMI. As an example, a borrower might come up with a down payment of 10 percent, take out a piggyback mortgage equal to another 10 percent of the home’s value, and take out a conventional loan for the other 80 percent.
The CFPB notes that piggyback mortgages were more common during the mortgage boom in the early to mid-2000s. This type of mortgage is rare today but could return, the bureau says.
Pros of taking out a piggyback mortgage:
- You won’t have to pay PMI. Since your conventional home loan is at 80 percent of less (signifying 20 percent equity, even if some of the equity is artificial), you won’t have to pay PMI.
- You can get into the home you want sooner. By saving up a smaller down payment, you may be able to get into the home you want sooner.
Cons of taking out a piggyback mortgage:
- Piggyback loans interest rates. Since piggyback loans typically come in the form of a HELOC, the interest rate is usually variable. Not only that, but the interest rate is typically higher than you would pay on a conventional loan. The higher interest charges may wipe out any savings you get from avoiding PMI.
- It may be harder to refinance down the line. The CFPB notes that having two mortgages on your home can make refinancing later on a much more difficult feat.
Who is this option good for?
- Taking out a piggyback loan can be a good option if paying PMI would lead to higher mortgage costs overall. Make sure to compare both options – getting a piggyback mortgage and paying PMI – to see which one would cost you less in the long term.
VA loans are available to U.S. veterans who meet certain criteria. According to the Department of Veterans Affairs, you need satisfactory credit, a sufficient income, a record of military service and a Certificate of Eligibility (COE) to qualify.
Because these loans are intended to help veterans purchase properties and are backed by the federal government, they don’t require a down payment or PMI.
The Loan company SoFi also offers a home loan that doesn’t require PMI, with the caveat that you need strong credit (a FICO score of 700+) to qualify.
Pros of VA loans and other loans that don’t require PMI:
- You don’t need a down payment to qualify for a VA loan. Without having to save up for a down payment, you can get into the home of your dreams faster.
- You can avoid PMI altogether. VA loans and loans from certain lenders, including SoFi, don’t charge PMI.
- Your monthly payment could be lower. Without the need to pay PMI, your monthly payment could be lower.
- VA loans have very lenient requirements. VA loans specifically may be available to people with poor credit, and even those who have faced foreclosure.
Cons of VA loans and loans that don’t charge PMI:
- VA loans aren’t available to everyone. Because VA loans are a military benefit, they are only available to qualified veterans and their unmarried, surviving spouses.
- These loans aren’t fee-free. While VA loans don’t charge PMI, they do charge a one-time funding fee equal to 0.50 to 3.3 percent of the loan amount, depending on service history and other factors. Not everyone has to pay the funding fee, however, since some veterans are exempt.
Loans from SoFi that don’t require PMI require a substantial down payment. SoFi home loans that don’t charge PMI still require you to put at least 10 percent down.
Who is this option best for?
- VA loans are ideal for veterans who qualify and want to avoid PMI or putting down a large down payment. Meanwhile, home loans that don’t charge PMI can be a good option for qualified buyers with good credit.
Generally speaking, borrowers who took out a new FHA loan after June 3, 2013, will need to pay mortgage insurance premium, or MIP, for the life of their loan. (There is, however, an escape hatch: Borrowers with a FHA loan do have the option of building up at least 20 percent equity in their property, then refinancing into a conventional home loan.)
As for PMI, cancellation is indeed a possibility once the homeowner gets at least 20 percent equity in a home. However, early cancellation isn’t automatic. The borrower may have to take several steps to get the PMI taken off the loan, and the process can take several months to complete.
According to the CFPB, the Federal Homeowners Protection Act provides a path for homeowners to get PMI canceled early. The rights in this act apply to mortgages on single-family dwellings closed on or after July 29, 1999, so all new loans apply.
Borrowers have the right to request that their loan company cancel PMI when they have reached the date when the principal balance of the mortgage is scheduled to fall to 80 percent of the home value. The date when this is scheduled to happen should be given to you in writing at your home closing, says the CFPB.
If you have made additional payments that reduced your home loan well below 80 percent of original value, you can request that private mortgage insurance be taken off earlier. As the CFPB notes, “original value” usually means the contract sales price of your home or the appraised value of the home when you purchased it, whichever is lower.
To request that PMI be taken off early, you must:
- Make a request in writing
- Have a good payment history and be current on monthly payments
- Be willing and able to certify there aren’t any liens on your property
- Be willing and able to provide evidence of your home’s value, which may include paying for an appraisal
Remember that you can only make this request when your loan-to-value ratio is at least 80 percent. To calculate your loan-to-value ratio, you can take your loan amount and divide it by your property value.
If you owe $150,000 on a property worth $200,000, for example, your loan-to-value ratio would be 75 percent.
It’s also worth noting that your PMI will be canceled automatically at a certain point if you have a conventional home loan. According to the CFPB, your servicer must automatically terminate PMI “on the date when your principal balance is scheduled to reach 78 percent of the original value of your home.” At that time, you do need to be current on your payments to have your PMI automatically canceled.
If you are currently paying PMI and want to stop paying it as soon as possible, it’s important to note there are several ways to speed up the process. Here are a few ways to get PMI out of your life sooner rather than later:
#1: Refinance your mortgage.
If your home value has risen since you purchased your property and you now have at least 20 percent equity, you may be able to ditch private mortgage insurance by refinancing your home loan. Keep in mind, however, that there are costs associated with refinancing. Before you refinance to avoid PMI, make sure to compare the costs of refinancing to what you may pay in PMI.
Also make sure to consider your old and new interest rate. Before you pull the trigger, make sure refinancing will really save you money.
#2: Get a new appraisal.
If you can prove you have 20 percent equity in your home with a new appraisal, you may be able to request early PMI termination from your lender.
#3: Pay extra toward your loan, or make biweekly payments to pay your loan off faster.
Morgan notes that, many times, the best way to get rid of PMI is to pay extra toward your home loan. “Pay down principal every month, even if only a few bucks,” he says.
To pay it down even faster, he says, you can also make biweekly mortgage payments instead of monthly payments. However, you shouldn’t hire an outside service to manage your payments because doing so is “usually too expensive.” Learn more about the pros and cons of making biweekly mortgage payments through MagnifyMoney.com, which is owned by LendingTree.
Once you pay down your loan to the point where you believe you have at least 20 percent equity, you can follow the steps outlined above to request early PMI termination from your lender.
Before you decide whether to pay PMI – or whether you should try to avoid it – it pays to learn all you can about this insurance product. Consider these frequently asked questions and their answers as you continue your path toward homeownership.
Q. Is PMI tax-deductible?
According to David Reiss, professor of law and academic program director for the Center for Urban Business Entrepreneurship at Brooklyn Law School, PMI may be tax-deductible but it all depends on your situation. “The deduction phases out at higher income levels,” he says.
According to IRS.gov, the deduction for PMI starts phasing out once your adjusted gross income exceeds $100,000 and phases out completely once it exceeds $109,000 (or $54,500 if married filing separately).
Q. If I take out an FHA loan, do I have to pay PMI?
FHA loans don’t charge borrowers PMI, but they charge mortgage insurance premiums, or MIP. Mortgage insurance premiums typically cost 1.75 percent of the loan amount upfront, along with an ongoing premium that is added to your monthly mortgage payment.
Q. Does PMI get automatically canceled once you owe less than 80 percent of your home’s value on your mortgage?
PMI is not automatically canceled until the date your loan was originally scheduled to reach 22 percent equity. To get PMI canceled sooner, you have to prove to your lender you have at least 20 percent equity in your property, be current with monthly payments, and make a formal request in writing.
Q. What is an amortization schedule?
When you originally took out a mortgage, you probably noticed mention of an amortization schedule. This is a timetable that illustrates the scheduled repayment of a mortgage. It shows how much is scheduled to be applied to principal and interest every month, as well as when the mortgage should be paid off.
Q. Can you get PMI taken off your loan if you’re struggling to make payments?
As the CFPB notes, lenders require you to be current on monthly mortgage payments to have PMI taken off your loan. This is true whether you request to have PMI taken off early or wait for it to automatically cancel.
Q. What components make up a monthly mortgage payment other than PMI?
Your monthly mortgage payment will likely be made up of principal and interest determined by your loan amount and interest rate, private mortgage insurance (PMI) or mortgage insurance premium (MIP) if applicable, property taxes, and insurance. The shorthand for the total cost of your mortgage is called PITI.
Q. What do you do if you’re struggling to make your mortgage payments?
If you’re struggling to make payments, the CFPB suggests finding a housing counselor who can help assess your situation and give personalized advice. Check out this page on the CFPB website for details on how to find a qualified housing counselor in your area.