Understanding Private Mortgage Insurance (PMI)
Sidney Richardson7-Minute Read
December 31, 2021
When you get a mortgage, you’ll sometimes have to pay for an extra expense called private mortgage insurance, or PMI. This insurance payment can potentially cost you a few thousand dollars extra each year – luckily, it can be avoided. What exactly is PMI insurance, and who or what does it protect? Let’s break down the details of what PMI is, how much it could cost you and how to get out of paying it to save on your monthly mortgage payments.
What Is Private Mortgage Insurance (PMI)?
PMI is a type of mortgage insurance that is usually required for borrowers of conventional loans. If you make a down payment of less than 20% on a house, you’ll be required to pay for PMI until you reach 20% equity. This form of insurance protects your lender if you stop making payments on your mortgage. Borrowers who make lower down payments are considered more of a risk to lenders, and thus must pay PMI until they reach 20% equity in the home.
While it can be frustrating to make this extra payment, it doesn’t last forever. Plus, if you make a 20% down payment upfront, you can usually avoid paying it at all.
When Is PMI Required?
PMI is required when you have less than 20% of equity in your home.
Home equity is the difference between your home’s value and what you owe your lender. This is the portion of your home’s value that you actually own. If the value of your home is $400,000 and you owe $320,000 on the mortgage, you have $80,000 of equity, or 20% equity in percentage form.
When buying a home, you automatically get some equity if you purchase the home at a price that’s below its appraised value. You also get equity with your down payment. For example, if you put down 10%, you have at least 10% in equity in the home – as long as you buy it at or below the appraised value.
Once you own the home, you build equity by paying off the principal balance of your loan when you make mortgage payments. You can also gain equity if the value of your property goes up. Once you hit 20% equity, you can contact your lender and request to stop paying PMI. Once you reach 22% equity, lenders will typically cancel your PMI payments automatically.
Most borrowers have to pay for PMI on a conventional loan if they make a down payment of less than 20% of the home’s purchase price. If you refinance a conventional loan, you will also have to pay PMI if you have less than 20% equity in the home.
Different Types Of PMI
When paying for PMI, there are a few different ways you can go about doing so. While your total annual PMI cost won’t change based on the way you decide to pay it, you can choose how to split it up.
- Borrower-paid mortgage insurance: This is probably the most common way to pay for PMI. Borrowers make payments toward their PMI each month bundled in with their monthly mortgage payment to cover a portion of their annual PMI premium.
- Lender-paid mortgage insurance: If you qualify and your lender allows it, you may be able to have your lender pay your PMI in exchange for a slightly higher interest rate on your loan. This could make sense if your monthly payment ends up being lower with the higher interest rate than it was with the added on monthly insurance cost.
- Single-premium mortgage insurance: Rather than splitting your PMI costs up over a year of payments, you can choose to pay the whole thing upfront as a lump sum, if you’d like. You would do this when taking care of other closing costs when you close on your loan.
- Split-premium mortgage insurance: If allowed by your lender, you can also pay a portion of your PMI upfront as a lump sum and the rest in monthly payments. This can help you make your monthly PMI payments smaller.
How Much Is PMI?
The annual cost of PMI will be different for every homeowner based on their lender and unique financial situation. In general, though, PMI tends to cost around 0.1% – 2% of your loan amount each year. So, if you owe $300,000, you can expect to pay $300 – $6,000 per year.
If you itemize your tax returns, the Internal Revenue Service (IRS) has previously allowed borrowers to deduct their PMI costs from their taxes. However, the IRS has not yet extended this deduction to 2022, so it’s currently uncertain if this deduction will still be available next spring. You can check the IRS website for updates on this matter as tax season approaches.
How To Avoid PMI
You probably want to get out of paying for mortgage insurance as soon as possible in order to save money over the life of your loan. Luckily, there are a few ways you can go about doing that.
Make A Larger Down Payment
Making a down payment of at least 20% on your mortgage is the easiest way to avoid PMI because it prevents you from having to pay for it in the first place. Obviously, 20% can be a lot of money to save. For example, if you’re buying a house worth $250,000, a 20% down payment would be $50,000.
If you’re financially able to take the extra time and effort to save up for a larger down payment, it can pay off in more ways than just getting rid of PMI. The larger down payment you make, for instance, the lower your monthly mortgage payment will be.
Reduce Your House Budget
If you want to avoid extra costs like PMI but can’t afford a large down payment, it may be worth considering lowering your budget when you’re searching for homes. Just because you can get approved for a certain amount of money with a lender doesn’t mean that’s what you should spend. It may be better for your finances to find a house that’s on the lower end of your budget, if that’s an option.
Before you start house hunting, check out our home affordability calculator to help you get a better idea of how much you should spend.
Consider Lender-Paid Mortgage Insurance
If PMI payments would be more expensive for you annually than paying a slightly higher interest rate, you could also consider asking your lender about lender-paid mortgage insurance, which we talked about earlier. This option would allow you to avoid PMI but may not always be worth it. A higher interest rate means you’ll pay more in interest over the life of your loan, which could be an amount more substantial than what you’d pay for PMI.
Apply For An FHA Or VA Loan
If you qualify, getting a government loan rather than a conventional one is another way to avoid PMI.
Federal Housing Administration (FHA) loans are intended for low- to median-income borrowers that may not have perfect credit. These loans help make homeownership more affordable for those that qualify. With an FHA loan, you could get a lower interest rate, less strict qualification requirements and avoid paying for PMI – but there’s a catch. The FHA has its own mortgage insurance, called a mortgage insurance premium (MIP). MIP comes in two parts: an upfront premium and monthly premiums after closing. Before taking the dive on an FHA loan, do your research on MIP vs. PMI and find out whether you would truly save by making the switch.
If you happen to be a veteran, qualifying active-duty service member or surviving spouse, you may also qualify for a Department of Veterans Affairs (VA) loan. VA loans boast low interest rates, no down payment requirements, more lenient credit requirements and best of all, no PMI. There is a one-time, lump sum VA funding fee that borrowers typically must pay, but no mortgage insurance.
Find Down Payment Assistance
If you want to make a large down payment to avoid PMI but can’t afford to, you may still have options. There are many programs both state-, federal- and lender-offered that can give you down payment assistance, depending on your income and financial situation. Many of these programs allow borrowers to take out a low interest rate loan to cover some of their closing costs, and some even come in the form of grants that don’t need to be repaid.
Even if you still can’t make a down payment of 20% with the help of down payment assistance, you may be able to shorten the period of time that you are required to pay PMI.
The U.S. Department of Housing and Urban Development (HUD) keeps a list of homeownership assistance programs by state as well as a list of grants you can peruse to see if you may qualify for financial assistance.
How To Get Rid Of Existing PMI
If you’re already paying PMI, the best way to get rid of it is to be up to date on your mortgage payments and:
- Reach at least 20% equity in your home and request cancellation
- Reach 22% equity and have your PMI automatically canceled
- Refinance to a government mortgage like an FHA or VA loan
Before making any decision that will impact your mortgage payment, always do your research, speak to a financial adviser and consult a home loan expert to make sure you’re making the best choice for your finances.
The Bottom Line
PMI is required of most conventional loan borrowers that make a down payment of less than 20% on their loan. Most homeowners have to pay this insurance until they build enough equity in their home, but there are ways to get out of PMI, too, like making a larger down payment, refinancing to a government loan or lowering your housing budget before hunting for a home.
Want to learn more about some of the other costs of homeownership? Check out our complete guide to the costs of owning a home.
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