If you’re buying a home with a conventional loan and put down less than 20% of the purchase price, most lenders will require you to pay a monthly fee for private mortgage insurance, commonly known as PMI.
You may wonder: What is PMI and why do I need it? The answer is that PMI reimburses lenders for their losses if a borrower fails to repay their mortgage. You may not need PMI, but if your down payment is less than 20%, your lender needs PMI to protect its investment.
By understanding how PMI works and how much it costs, you can decide if it’s worth paying extra each month to buy a home, or if you’d be better off avoiding PMI by making a larger down payment or buying a less expensive home:
- What Is PMI?
- How Does PMI Work?
- Do You Need PMI?
- How Much Does PMI Cost?
- How To Avoid PMI
- How To Get Rid of PMI
- Private Mortgage Insurance FAQ
- The Bottom Line on PMI
What Is PMI?
PMI is an insurance policy issued by a private company that reimburses the lender for its losses if the borrower is unable to repay the loan.
Because home loans with smaller down payments pose a greater risk of default, lenders require borrowers with those mortgages to pay for PMI.
How Does PMI Work?
Lenders typically require borrowers to pay for PMI when they’re buying a home with a down payment of less than 20% of the purchase price, or when they refinance and have less than 20% home equity under the new loan.
If you default on your mortgage, then PMI compensates the lender for its losses.
Once you have more than 20% equity, you can ask your lender to cancel your PMI coverage and stop paying for it. Lenders often cancel PMI automatically once you have 22% equity in your home.
Do You Need PMI?
If you put down less than 20% of the purchase price when buying a home with a conventional loan, then your lender will need you to pay for PMI.
PMI is an additional monthly expense that only protects the lender. While many buyers agree to pay it in order to buy a home and start building equity sooner, others consider it an unnecessary expense.
“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.
If you can only afford a small down payment, but are otherwise qualified for a conventional mortgage, paying for PMI may be an acceptable trade-off for getting the mortgage and buying a home.
“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.”
How Much Does PMI Cost?
PMI costs roughly $30 to $70 per month for every $100,000 borrowed.
Here’s an example:
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 find PMI costs on Page 1 of your loan estimate and closing disclosure, under the section labeled “Projected Payments.” You’ll get the loan estimate within three business days of applying for a mortgage, and you should expect the closing disclosure at least three business days before you close on the loan.
Factors that affect your PMI rate
The exact cost of your PMI premium will vary depending on factors such as:
- Down payment size. A smaller 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. If you’re making a smaller down payment, then you’ll likely be charged more in PMI.
- Loan amount. Since PMI costs about $30 to $70 per month for every $100,000 you borrow, you can expect to pay more with a larger loan.
- Interest rate type. If you have a fixed-rate mortgage, your interest rate stays the same. With an adjustable-rate mortgage, your rate changes based on market conditions. Because fixed-rate mortgages carry less risk, choosing this interest rate type could mean paying less for PMI.
- Credit history. Having a high credit score and a history of responsible borrowing habits could help keep your PMI premiums to a minimum.
Ways to pay for PMI
The most common way to pay for PMI is to have it added to your monthly mortgage payment. However, you can also include it in your closing costs and pay for it in part or as a lump sum.
There are several kinds of PMI, and each one works differently:
- Borrower-paid mortgage insurance. Your premium will be added to your monthly mortgage payment. This can be removed once you reach 20% home equity.
- Lender-paid mortgage insurance. The lender pays the PMI premium in exchange for charging you a higher interest rate on the loan.
- Single-premium mortgage insurance. Instead of a monthly payment, you pay upfront for PMI coverage in a lump sum.
- Split-premium mortgage insurance. This option allows you to pay part of your PMI bill as a lump sum at closing, and the rest with ongoing monthly payments. This would lower your monthly PMI payment.
PMI is for conventional loans. Loans backed by the Federal Housing Administration, Department of Agriculture, and Veterans Affairs either require other types of mortgage insurance or charge other upfront fees.
How To Avoid PMI
If avoiding PMI is your goal, consider:
- Waiting to buy a home until you save up for a down payment of at least 20%.
- Holding off on refinancing until you can do so while retaining at least 20% equity.
- Looking for mortgage lenders or loan types that don’t require PMI. However, keep in mind that you could wind up with a higher interest rate and a pricier loan.
How To Get Rid Of PMI
You can remove PMI from your monthly payment once you’ve built 20% equity in your home. When you hit that point on your amortization schedule, you can contact your lender and ask to remove the PMI premium from your monthly payment.
Lenders may require homeowners to pay for a new home appraisal before allowing them to stop PMI payments, says Jason Priebe, a certified financial planner and partner at Priebe Wealth, a wealth advisory firm in Maple Grove, Minnesota.
Otherwise, the PMI policy should automatically terminate on the date that your principal balance reaches 78% of the home’s original appraised value.
Another way to get rid of PMI is by investing in home improvements that increase your property value. If your home’s value rises significantly due to those improvements, you can reach out to your lender and request to have your PMI canceled.
You can also ask to remove PMI if there have been natural increases in your property value two to five years after your closing date. But keep in mind that there might be restrictions based on your loan-to-value ratio.
Private Mortgage Insurance FAQ
Here are answers to some frequently asked questions about PMI.
Yes, deducting PMI is one of the tax benefits of owning a home. 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 unavailable.
PMI compensates the lender for its losses if you’re unable to repay the mortgage.
“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.
PMI is for conventional loans, which aren’t backed by a government program. MIP refers to mortgage insurance premiums, which are required for FHA loans.
The Bottom Line on PMI
You can expect to pay for PMI if you’re planning to buy a home with a conventional loan and put down less than 20%. 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, as long as you’re otherwise qualified. 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.