What Is Private Mortgage Insurance?
Christy Bieber is a personal finance and legal writer with more than a decade of experience. Her work has been featured on major outlets including MSN Money, CNBC, and USA Today.
Private mortgage insurance (PMI) is required when you have very little equity in your home because your down payment was small -- less than 20% of the home's value.
Although the cost of PMI is added on to the mortgage payments that borrowers must make, the insurance protects the lender rather than the home buyer. Lenders require it to ensure they can recoup all of their costs if they have to foreclose on a home that was purchased with a small down payment.
What is private mortgage insurance (PMI)?
Private mortgage insurance is an added cost that most homebuyers must bear when they purchase a home with a down payment that is below 20% of the purchase price.
Lenders want to make sure they can recoup their costs if they have to foreclose on your home or repossess it because you haven't paid the bills. If this happens, a lender needs to make up the unpaid loan amount plus any costs. PMI covers the lender if it can't recover enough money from a forced sale.
Lenders secure PMI but pass the costs on to borrowers. If you purchase a home with a low down payment, you'll have no choice but to pay the amount the lender requires for your PMI policy. If you can't make your mortgage payments, PMI won't stop a foreclosure from happening, and it doesn't protect you as a buyer from losing money; it only protects the lender.
How much does PMI cost?
The cost of private mortgage insurance is a percentage of your mortgage amount, and as such, the cost depends on how much you borrow. That premium is usually between 0.5% and 1% of the amount you borrowed per year. On a $300,000 mortgage loan, you'd pay between $1,500 and $3,000 each year, depending on the premium you're required to pay for PMI.
Although premiums are priced as an annual percentage of your loan amount, you usually make your payments each month when you pay your mortgage bill. If your premiums are $3,000 per year, they'll add $250 to your monthly mortgage payment. On a $300,000 loan at 3.92% interest, that would mean PMI raises your monthly payment from about $1,418 per month to $1,668 per month.
How long do you pay PMI?
You'll have to pay for private mortgage insurance until your loan balance drops to 78% of the original appraised value of your home. If your home was valued at $350,000, you would have to pay PMI until your loan balance drops to $273,000. At that point, your lender would be required to automatically stop charging you for PMI.
You can also request an end to paying PMI premiums once your loan balance has dropped to 80% of your home's value. You'd have to ask your lender in writing to stop charging you for PMI at this point. Otherwise, you can wait until PMI is automatically removed.
If your home appreciates in value quickly, you may be able to ask your lender to drop the PMI before your loan balance reaches 80% of the home's original appraised value. For example, let's say your $350,000 home increases in value to $400,000. You wouldn't have to wait until you had paid your loan down to $256,000 (80% of the original value); you could ask your lender to stop charging PMI when your loan balance reaches $320,000 (80% of the current value). In this case, your lender would likely want an appraisal.
How to avoid paying for PMI
The best way to avoid having to pay for PMI is to make at least a 20% down payment on your home.
You could also look for loans that don't require it, although most do. While FHA and USDA loans don't require private mortgage insurance, they still require mortgage insurance. The VA doesn't require any kind of mortgage insurance for VA loans, but loans from the Veterans Administration are available only for qualifying military members and their families -- and they come with an upfront fee that many conventional loans don't require borrowers to pay.
Some mortgage lenders might let you avoid PMI with an 80/20 loan or a 90/10 loan, which means you take out two loans with two monthly payments. Depending on which option you choose, you'd essentially take out a mortgage for 80% or 90% of your home's value and a second loan for 20% or 10% to cover the down payment. You'll usually need excellent credit and a low debt-to-income ratio to do this, and not all lenders allow it.
PMI is insurance some lenders require you to purchase if your down payment for a home is below 20%. It's required because a low down payment could mean the house is not sufficient collateral to secure the loan.
The easiest way to avoid paying for PMI is to pay at least 20% down when purchasing a home. You could also see if you're eligible for a VA loan or an 80/20 loan.
Almost all mortgage lenders require PMI, including both mortgage lenders for bad credit and lenders targeting good credit borrowers. While FHA and USDA loans don't require private mortgage insurance, they still require insurance on loans.
PMI may help you buy a house without saving up 20% of the loan amount for a down payment. This in turn can allow you to stop paying rent and start benefiting from rising property prices if home values are going up in your area. However, it makes your mortgage payment more expensive, so it's best to save up for a home if you can. Your mortgage rate may also be higher if you can't make a sufficient down payment, because the lender takes on more risk when you have limited equity in your home.