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Guide to Understanding Private Mortgage Insurance (PMI)
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Insurance isn’t something most of us think about a lot, but it can be key to getting us through tough financial times. Health insurance helps cover hospital bills, while car insurance can help with a fender bender. In the same way, private mortgage insurance (PMI) can help if you are having a difficult time paying your mortgage. That’s true, to a point. Here’s a guide to PMI, to help you understand why you might need to have it (whether you want to or not), who it really protects and how to avoid it.
- PART I: The basics of private mortgage insurance
- Part II: Paying for PMI
- Part III: How to avoid PMI
- Part IV: How to cancel your PMI
- Part V: FAQs
PART I: The basics of private mortgage insurance
What is PMI?
PMI is insurance that protects your lender if you stop making mortgage payments and your lender has to foreclose on your home. Granted, it’s a worst-case scenario, but if it were to happen, your lender would need to sell the home through a foreclosure sale. Still, there’s a possibility your home may not sell for enough money to pay back the cost of the lender’s loan to you, and that’s when PMI kicks in. It helps make up the difference between what your home is worth and the balance on your mortgage. PMI may seem like an extra, unnecessary expense to you as a borrower, but it also lowers the risk to your lender, ultimately making lending money less precarious.
Which loans require PMI?
PMI is typically required for:
- Conventional loans. If you buy a home with a conventional loan (a loan that is not government-insured, such as an FHA loan) and your down payment is less than 20%, you may be required to purchase PMI.
- Refinances with a conventional loan. If you are refinancing your mortgage and you have less than 20% equity in your home, you may be required to take out PMI. Equity is the amount of your home you actually own, and it’s based on the value of your home minus the balance on your mortgage. For example, if you owe $100,000 on your home, but it’s valued at $150,000, you have $50,000 (or 33%) of equity in your home.
Loans that don’t require PMI
Government-insured loan programs don’t require PMI, but they often require something similar. For example, FHA loans require you to pay a mortgage insurance premium (MIP), so you are still paying for a type of insurance if you were to foreclose. However, the amount you’ll need to pay for PMI will vary based on factors such as your credit score and loan-to-value ratio (LTV), while an MIP rate for an FHA loan is the same regardless of your credit score.
VA loans require you to pay a funding fee instead of PMI or other mortgage insurance. This is a one-time fee, and the amount varies depending on the size of your down payment. In some cases, the fee may be waived. USDA loans also have an up-front fee (called an up-front guarantee fee), but the amount is capped at 0.35% of the loan amount.
PART II: Paying for PMI
The cost of PMI
PMI costs can be difficult to predict. They typically range from 0.15% to 1.95%, but they may reach 2.5% or more, depending on factors such as the following:
- The amount of your down payment
- Your credit score
- Your mortgage type (usually higher for an adjustable-rate mortgage)
- The term of your loan (may be higher for a 15-year loan)
- Your debt-to-income ratio (can be higher if more than 45%)
- Your loan-to-value ratio (may be higher for a loan-to-value ratio of 90% or more)
- The type of property you are purchasing (may be higher for a second home, manufactured home, condo, co-op or 3- to 4-unit property)
According to the Consumer Financial Protection Bureau (CFPB), your PMI premium will be spelled out on both the loan estimate you receive from your lender when you apply for a mortgage and your closing disclosure. Still, to get an idea of what to expect, consider checking a PMI calculator. For example, if you buy a $100,000 home and put down 10%, and you have a credit score of 760 or higher, you can expect an estimated PMI payment of $29.25 per month. On the other hand, if you have a lower credit score, 620 to 679, your estimated payment might be almost double that amount, or $53.25 per month.
How to pay for PMI
Borrowers typically use three ways to pay for PMI:
- Monthly premium payments: With this option, the premium payment is lumped in with your mortgage payment.
- Up-front premium paid at closing: By paying your premium up front, you can avoid higher monthly payments over the course of your loan. However, the CFPB cautions borrowers that if you sell your home or refinance, the premiums you paid up front will not be refunded to you.
- Up-front and monthly premiums: With this option, you pay part of your PMI up front and then pay the balance monthly, along with your mortgage payments.
Your lender may offer one or more of these options and, in some cases, may even be willing to shoulder the entire cost of PMI (see below). Ask your lender about payment options to determine which makes the most sense for you. Be sure to look at the total cost of PMI insurance over the life of your loan, and carefully consider how long you plan to live in your new home.
PART III: How to Avoid PMI
It’s possible to avoid having to pay to PMI at all. Here are some options, along with pros and cons.
Save up for a down payment
This is the simplest way to steer clear of PMI. If you can come up with a 20% (or more) down payment, your lender won’t require it.
Pros of saving for a down payment:
- You’ll pay off your mortgage faster: A bigger down payment means a smaller loan balance that’s easier to pay down.
- Your monthly payments will be smaller: With a bigger down payment, there’s less loan balance to finance, and your monthly payments are smaller.
- It can balance out a less-than-stellar credit score: A 20% (or more) down payment makes you less of a risk to lenders, so they may be more willing to work with you even if your credit isn’t perfect.
Cons of saving for a down payment:
- It takes time: Saving up for a 20% down payment takes time. For a $100,000 mortgage, you would need $20,000. If you save $1,000 per month, it would still take more than a year and a half to save that amount.
- It might eat up all your savings: A 20% down payment might leave your bank accounts empty, with nothing to cover emergency expenses.
Who might benefit most:
This option is best for those with substantial savings or those who live in lower-cost neighborhoods. A lower home price means you have to save up less to be able to put 20% down.
Get a piggyback loan
A piggyback loan is a second mortgage that provides cash to buyers taking out a primary mortgage so they have enough to reach a 20% down payment. For example, a home loan package with a piggyback loan might be described as 80-10-10, which means the primary mortgage covers 80% of the amount needed to purchase the home, a second mortgage covers 10% and the buyer provides the other 10% as a down payment.
Pros of a piggyback loan:
- It’s less taxing on your savings: You only need to come up with 10% of the purchase price, rather than 20%.
- Your interest rate could be lower: By putting 20% down, you might qualify for a lower interest rate on your mortgage.
Cons of a piggyback loan:
- You’ll have two loan payments: Your piggyback loan is a separate mortgage, so you’ll have two payments to keep track of each month instead of one.
- A refinance could be a challenge: According to the CFPB, refinancing a mortgage with a piggyback loan could be tricky since both lenders have to agree to the refinance, unless you’re able to pay off the piggyback loan with the refinance.
Who might benefit most:
This option is best for those who can afford a 5% (or more) down payment. Take the time to compare a mortgage with a PMI payment versus a mortgage with a piggyback loan; the piggyback loan option might cost less.
Get a lender-paid mortgage insurance loan
Some lenders are willing to pay PMI costs rather than passing them on to you. This is referred to as lender-paid mortgage insurance.
Pros of lender-paid mortgage insurance:
- You can make a lower down payment: Instead of having to come up with a 20% down payment, you’ll just need to come up with the minimum required by your lender, typically 10% to 15%.
Cons of lender-paid mortgage insurance:
- Your interest rate may be higher: Your loan’s interest rate may be higher than it would be if you paid the PMI yourself.
- You will need good credit: To qualify for this type of mortgage, you will probably need a credit score of 740 or higher.
Who might benefit most:
This option is best for those who have very good credit and enough savings to put at least 10% down.
Consider a VA loan (if qualified)
VA loans offer competitive interest rates to veterans, active members of the military and the reserves, and eligible surviving spouses. These loans don’t require a down payment or PMI.
Pros of VA loans:
- You can borrow more than 80% of a home’s value: Even if you don’t have enough savings for a large down payment, you may be able to borrow enough to get the home you want.
- Flexible loan requirements: There’s no set minimum credit score for a VA loan, so even if your credit history is spotty, you may still qualify.
Cons of VA loans:
- There are still fees: Lenders charge a funding fee of 1.25% to 3.3% of the loan amount, although you may be able to roll the fee into the total you owe.
- You need to meet certain income requirements: You’ll need to show you have enough income to cover the cost of the mortgage plus any other debt payments.
Who might benefit most:
Consider an FHA loan (if qualified)
Federal Housing Administration (FHA) loans don’t require you to pay PMI, but they still come with similar fees.
Pros of FHA loans:
- Very low down payment requirements: You can make a down payment of as little as 3.5% and still qualify for an FHA loan.
- Flexible credit requirements: The minimum credit score for an FHA loan is 580, but if you make a 10% down payment, you may qualify with a score as low as 500.
Cons of FHA loans:
- The fees: With an FHA loan, you will need to pay an up-front mortgage insurance premium (MIP) equal to 1.75% of the loan amount. You’ll also have an annual mortgage insurance premium (MIP) that is paid monthly, and that’s based on 0.45% to 1.05% of your total loan amount depending on your mortgage term, loan amount and LTV.
- The fees may be forever: Once you build up enough equity in your home, you can cancel PMI (see below for details). However, with an FHA loan, you pay the MIP charges for the life of the mortgage if you made the minimum 3.5% down payment.
Who might benefit most:
FHA loans are best for those who have less-than-perfect credit and who might not qualify for a conventional mortgage, which typically comes with fewer income and property limits. Still, when MIP fees are added up, they can make monthly FHA loan payments more expensive than payments for similar conventional mortgages.
Consider a USDA loan (if qualified)
USDA loans help borrowers in rural areas secure home loans. They have low interest rates, but they also have income limits. They do not require mortgage insurance, but they do have other, similar fees to consider.
Pros of USDA loans:
- No down payment requirement: You can buy a home without any down payment at all.
Cons of USDA loans:
- You must meet income requirements: Household income limits vary depending on the state and county where you live; but, in general, you must have a low to moderate income.
- There are still fees: You must pay an up-front guarantee fee of 1% and an annual fee of 0.35%, which is rolled into your mortgage payment.
Who might benefit most
USDA loans are best if you live in a rural area and have a modest household income.
PART IV: How to cancel your PMI
PMIs and MIPs aren’t always forever. You may be able to eventually cancel private mortgage insurance if you meet certain requirements (see below). You may also be able to cancel MIP payments on an FHA loan if you made a down payment of 10% or more and have made payments for 11 years. With both types of insurance, put your request in writing and be sure to follow up with your lender.
PMI cancellation requirements
- You must have a good payment history
- You must be current on payments
- Your lender may require you have no secondary mortgages on your home
- You may need an appraisal to show the value of your home hasn’t dropped
- You must have paid enough of the principal balance on your mortgage so your loan-to-value (LTV) ratio is 80% or less.
Your LTV compares your loan amount to the value of your home. For example, if you have a mortgage balance of $150,000, and your home is appraised at $200,000, your LTV is 75% (to get this number, divide $150,000 by $200,000 and multiply by 100). A 75% LTV is below the 80% needed to drop your PMI.
Tips for cancelling PMI sooner
If you don’t want to wait until you’ve reached an 80% LTV to cancel your PMI, consider these options for speeding the process along:
- Refinancing on your own: If your home value has increased and you now have at least 20% equity in your home, you may be able to refinance and qualify for a mortgage without a PMI. Before moving forward, make sure to scrutinize loan offers carefully to make sure they put you in a better financial position.
- Refinancing with a cosigner. Adding a cosigner with better credit might help you qualify for lender-paid PMI. The loan interest might be a little higher, but the overall monthly payment could be lower.
- Get a new appraisal. Home values can fluctuate depending on the market. If you think your home value has gone up, get a new appraisal to see if you meet the LTV ratio to drop your PMI.
- Make extra mortgage payments. Pay a little extra on your mortgage each month. The more you pay, the faster you will build up the equity needed to cancel PMI payments.
PART V: FAQS
Still have questions about PMIs and how they work? You might find answers below and at the Consumer Financial Protection Bureau website.
Q. Is PMI tax-deductible?
Under the new tax law, the itemized deduction for mortgage insurance premiums expired on December 31, 2017. It’s unclear whether Congress will pass new legislation to bring it back.
Q. If I take out an FHA loan, will I have to pay PMI?
Technically, FHA loans don’t have PMI. Instead, they require two types of mortgage insurance premiums (MIP). The annual premium is 0.45% to 1.05% of your loan amount; loans equal to or more than $625,500 charge more. However, you will also need to make an up-front MIP payment of 1.75% if your down payment is 3.5%. As noted earlier, these fees can add up quickly.
Q. Does PMI automatically get canceled when I hit 20% equity?
Your PMI will be canceled automatically once you reach 22% equity in your home (and your LTV is 78%). However, you will need to take the initiative to get it canceled when you have just 20% equity in your home. Your PMI will also be canceled automatically once you reach the midpoint of your amortization schedule (the payment schedule for the life of your mortgage), say, 15 years into a 30-year loan. To avoid paying more PMI than necessary, keep a close eye on your equity and send a letter as soon as you hit 20%.
Q. What happens if I fail to pay PMI?
Your PMI payments are bundled in with the rest of your mortgage payment, so there isn’t a way to avoid paying your PMI and remain up-to-date with your mortgage payments. If you are having trouble keeping up with your mortgage payments, talk to your lender or a housing counselor to discuss your options.
Q. Is PMI the same as homeowners insurance?
Your lender will typically require you to buy homeowners insurance even if you aren’t required to have PMI. PMI insurance protects the lender if you default on your mortgage. Homeowners insurance protects your home and the items in your home in the event of a disaster. Both payments may be included with your monthly mortgage payment; your lender usually holds the payments in escrow and then sends them to the insurance companies when they’re due.