PMI: What It Is, How To Calculate It And How To Avoid It
Lauren Nowacki6-Minute Read
June 25, 2020
Purchasing a home can be a big expense, both at the closing table and with monthly mortgage payments. It’s no surprise home buyers look for ways to get the lowest monthly payment possible. One easy way to do so is by avoiding private mortgage insurance (PMI). Wondering how you can keep it off your monthly payment? Read on to learn what PMI is, how much it costs and how to avoid it to achieve cost savings.
What Is PMI?
Private mortgage insurance is purchased by mortgage borrowers who don’t have 20% of the purchase price available for a down payment, for the benefit of lenders. It costs 0.5% – 1% of the mortgage balance each year, which is spread evenly throughout the year and added to your monthly mortgage payment.
How Can I Cancel PMI?
You can request the lender cancel your PMI once you have 20% equity in the home. It will also automatically drop off the loan once your mortgage balance is 78% of the original purchase price or once you’ve hit the midway point of your loan term. However, all three of these ways to cancel PMI take years to happen. Instead, you may want to try avoiding paying your PMI altogether.
How Can I Avoid Paying For PMI?
If you want to avoid PMI, you have two options: come to the table with a 20% down payment or see if you can have the lender pay for the PMI. Here’s how to accomplish either.
Save For A 20% Down Payment
A down payment is a required lump-sum payment you make at closing to purchase a home. The amount you pay is a percentage of the home’s value and helps add to the equity you have in the home from the get-go and reduces the amount you borrow. Most loans do not require a 20% down payment. However, having one will get rid of the PMI and could lower your monthly payment even more since it’ll also lower your principal balance. If you have time, consider saving for a 20% down payment before purchasing your home. Use a home affordability calculator to figure out how much you can spend on a house, then plan to save 20% of that.
Once you know how much you need to save, figure out the date you want to purchase your home. Divide the amount you need to save by the number of months you have until your purchase to determine how much you need to save each month. For example, if you need to save $10,000 in 10 months, your goal will be to save $1,000 each month.
Here are a few tips for saving:
- Review your budget and see where you can make cuts. Any money saved each month goes toward your down payment. If you don’t already have a budget, start one now.
- Get a side hustle and save all of your extra earnings.
- Put any bonus or tax return toward your savings goal.
- Sacrifice your daily coffee runs, restaurant dinners or your annual vacation and save the money instead.
- Sell your stuff. Host a garage sale, use an online marketplace or sell your gently worn clothes and accessories to a consignment shop.
Shop For A Less Expensive Home
If you don’t have a 20% down payment for a home that’s priced at the top of your budget, consider purchasing a more modest home at a price that you do have 20% of the value on hand to pay. For example, if you have $35,000 for a down payment, you could purchase a $175,000 house and have the full 20% down payment and avoid PMI. However, if you purchase a $200,000 instead, you would only have a 17% down payment and would be required to pay PMI.
There may be an additional bonus to this strategy. You may be able to quickly build up equity in a smaller home in an appreciating housing market, which could ultimately allow for the purchase of an even better with a healthy down payment home down the road. Of course, keep in mind, whether your home will appreciate in value depends on the housing market in general and the location of your home.
Consider Lender-Paid Mortgage Insurance
If you must have a PMI on a conventional loan through Fannie Mae or Freddie Mac, you may have two mortgage insurance options: borrower-paid mortgage insurance (BPMI) or lender-paid mortgage insurance (LPMI). The BPMI option is the one we’ve been talking about – the one you, the borrower, pay. The LPMI loan option, like PMI Advantage from Quicken Loans®, is one in which the lender pays your PMI upfront, which eliminates the monthly fee. The trade-off is that you’ll have a higher interest rate. However, you can still save money in the long run, especially if you don’t plan on living in the home very long. You can also choose to pay a one-time fee at closing instead, which can help save you money if the seller is willing and able to help pay for the cost.
Weigh Your Options Carefully
Sometimes, paying for PMI is more advantageous, in the long-term, than not paying. Both PMI and mortgage interest remain tax-deductible if you itemize deductions. However, if the standard deduction is higher than your itemized deductions, take the standard deduction because you’ll pay less in taxes. If this is the case, you don’t really benefit from the PMI deduction.
To determine whether it would benefit you to pay PMI and deduct it from your taxes, we recommend speaking to a financial professional who can make recommendations based on your specific situation.
Are There Different Options For FHA Borrowers?
PMI applies to conventional loans, not FHA loans. FHA borrowers will not have a PMI. However, FHA loans have something that conventional loans do not, and that is an upfront mortgage insurance premium (MIP). This charge cannot be avoided – regardless of your down payment. However, it can fall off the loan after 11 years if you pay a down payment of 10% or more. If your down payment is less than 10%, the MIP will stay on for the life of the loan. FHA borrowers can also drop their MIP by refinancing to a conventional mortgage once they have 20% equity in the home.
Summary: Plan Ahead To Avoid PMI
PMI is a fee for conventional mortgage borrowers who make a down payment of less than 20%. It can cost up to 1% of your mortgage balance each year and is added to your monthly payments. Instead of waiting for your loan balance to go down significantly or waiting until your halfway through your loan term, plan ahead to avoid PMI completely. Save for a 20% down payment before you purchase a home, consider purchasing a less expensive house or look into other options you may have. If you’re considering buying a home in the near future, read more home buying tips to help you save money and have an easier process.
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