Lenders usually require borrowers to purchase private mortgage insurance when they are taking out a conventional loan and their down payment is under 20% of the home’s purchase price. Homeowners who are refinancing to a conventional loan and have less than 20% equity also typically need to pay for PMI.
By understanding what PMI is for, how the insurance works, and how much it costs, you’ll be in a solid position to figure out whether you’re willing to pay for it — or if you’d be better off avoiding PMI. Here’s what you need to know about private mortgage insurance:
What Is PMI?
Private mortgage insurance, aka PMI, is a type of coverage that your lender may require you to purchase if you have a conventional loan and your down payment is less than 20% of the home’s purchase price. The policy is issued by a private insurance company and protects the lender if you stop making mortgage payments. Home loans with smaller down payments pose a greater risk for lenders, so PMI helps shield them from losses.
Do you need PMI?
It’s likely you will be required to pay for private mortgage insurance if you have a conventional mortgage and you’re putting less than 20% down. PMI is also generally required if you’re refinancing to a conventional loan and your home equity — or the difference between your home’s value and your mortgage balance — is below 20%.
If you have a government-backed loan, however, then the insurance works differently.
Those with loans backed by the Federal Housing Administration must pay mortgage insurance premiums that include both an upfront cost and a monthly premium for the life of the loan. If you can’t afford to pay the upfront mortgage insurance premium as part of your closing costs, then it can be rolled into your loan — though this will increase your mortgage balance and the overall cost of the loan. Those who pay the upfront cost and don’t default on monthly payments may be eligible for a partial refund of the mortgage insurance premium.
Direct loans from the U.S. Department of Agriculture don’t require mortgage insurance. With USDA guaranteed loans, you pay an annual guarantee fee in place of mortgage insurance, and it’s typically included in your monthly payment.
If you have a loan backed by Veterans Affairs, then mortgage insurance isn’t required. But keep in mind that you need to pay a one-time VA funding fee to help lower the cost of the program.
How PMI Works
Private mortgage insurance covers the lender against losses when a borrower is unable to repay their loan. When you’re a borrower paying for PMI, it’s important to understand that the insurance doesn’t protect you from foreclosure if you can’t afford to make your monthly mortgage payments.
“Your goal should be to put 20% down on a house, both to ensure you don’t have to pay PMI and you may also get a better rate and lower monthly payment,” says Jay Zigmont, a certified financial planner and the founder of Live, Learn, Plan, a fiduciary financial planning firm in Water Valley, Mississippi.
At the same time, if you have a small down payment but are otherwise qualified for a conventional mortgage, paying for PMI is one of the trade-offs to getting the mortgage. This also increases the overall cost of your loan.
“The hard part is that you may find a great house, but not be able to afford it,” Zigmont says. “If you have to pay PMI because the house is more than you can afford, you might want to look at another house.”
If you decide to make a small down payment with a conventional loan, you should know that PMI payments are commonly charged as a monthly premium, and don’t go toward paying down the loan principal. While PMI is often rolled into the mortgage payment, it’s still an additional cost. Other PMI payment options are a one-time, upfront premium at closing, or a hybrid method consisting of both an upfront fee and monthly premiums.
How Much Does PMI Cost?
Generally speaking, borrowers pay roughly $30 to $70 per month in private mortgage insurance for every $100,000 borrowed.
The exact cost of your PMI premium will vary depending on a variety of factors, including:
- Down payment size. A small down payment means the borrower has a higher risk of missing mortgage payments, and the lender will lose more of its investment if the borrower defaults on their loan. As a result, if you’re making a smaller down payment, then you’ll likely be charged more in PMI.
- Loan amount. Since the approximate cost of PMI is $30 to $70 per month for every $100,000 you borrow, you can expect to pay more for insurance on a jumbo loan than you would on a loan for an average home.
- Credit history. Having a high credit score and a history of responsible borrowing habits could help keep your PMI premiums to a minimum.
- Interest rate type. If you have a fixed-rate mortgage, your interest rate stays the same. With an adjustable-rate mortgage, however, your rate can fluctuate based on market conditions. Because fixed-rate mortgages carry less risk, choosing this interest rate type could mean paying lower PMI premiums.
Here’s an example of what PMI might look like for a $400,000 home with a 30-year mortgage at a 5% interest rate:
PMI for a $400,000 Home With a 30-Year Mortgage at a 5% Interest Rate
|Down Payment||Mortgage Insurance Premium||Monthly Payment|
You can expect to find PMI costs on Page 1 of your loan estimate and closing disclosure, under the section labeled “projected payments.” You should get the loan estimate within three business days of submitting your mortgage application, and you can expect to receive your closing disclosure at least three business days before you close on the loan.
How To Avoid PMI
If avoiding PMI is your goal, there are ways to sidestep this additional cost of homeownership:
- Wait to buy a home until you save up for a down payment of at least 20%.
- Hold off on refinancing until you have at least 20% equity.
- Look for lenders or other types of loans that don’t require PMI. However, keep in mind that you could wind up with a higher interest rate and a pricier loan.
“If you can avoid paying PMI … that is best,” says Jason Priebe, a certified financial planner and partner at Priebe Wealth, a wealth advisory firm in Maple Grove, Minnesota.
How To Get Rid Of PMI
You can remove private mortgage insurance from your monthly payment once you’ve built 20% equity in your home. When you hit that point according to your amortization schedule, you can contact your lender. Priebe says lenders may require homeowners to pay for a new appraisal before allowing them to stop PMI payments.
Otherwise, the PMI policy should automatically terminate on the date that your principal balance reaches 78% of the home’s original appraised value, as long as certain conditions are met.
Another way to get rid of PMI is by investing in home improvements that increase the value of your property. If your home’s value rises significantly due to those improvements — or changes in market conditions — you can reach out to your lender and request to have your PMI canceled.
Private Mortgage Insurance FAQ
Here are some frequently asked questions when it comes to private mortgage insurance.
Private mortgage insurance is tax deductible as long as the insurance contract was issued after 2006. If your adjusted gross income is higher than $100,000, then the amount you can deduct for PMI is reduced. If your adjusted gross income exceeds $109,000, then the deduction is no longer available.
However, this remains subject to change depending on the tax year. According to Priebe, the original tax deduction for PMI was part of the Tax Relief and Health Care Act of 2006 and extended in various forms to help the housing market recover after the crash.
“It is unknown how long this will last,” Priebe says.
You can stop paying for private mortgage insurance once you’ve built 20% equity in your home. When you reach 22% equity, your PMI premium should be automatically removed from your monthly payment.
Private mortgage insurance protects the lender against losses if you’re unable to make your monthly payments.
“It is essentially for the risk that the lender takes on by providing a mortgage to someone who doesn’t have at least a 20% down payment on their home,” Priebe says.
The Bottom Line on PMI
You can expect to pay for private mortgage insurance if you’re planning to buy a home with a conventional loan and put less than 20% down. PMI increases your monthly payments and the overall price of the loan. If you’re willing to take on this added expense, then PMI could help you buy a more expensive home with the down payment you have saved, as long as you’re qualified otherwise. But keep in mind that PMI only protects the lender, so if you avoid PMI, you can save the money that you’re spending for your lender’s benefit and work toward improving your own finances instead.