What Is Private Mortgage Insurance (PMI)?

How does private mortgage insurance work?

Your mortgage lender will typically choose a private mortgage insurance company and arrange coverage. PMI is not insurance that will protect you. It’s enforced by a mortgage lender to protect its investment, and it’s commonly found with conventional mortgage loans.

Despite the additional cost, PMI allows many individuals to become homeowners even if they can’t save enough for a 20% down payment. In fact, paying PMI may allow you to buy a home with as little as a 3% down payment. It’s also typically a short-term cost; PMI can usually be removed once you have 20% equity in your home. Once you’ve built up enough home equity, you can request to have the PMI removed, thereby reducing your monthly payments.

How to pay PMI

The main ways to pay PMI include:

Monthly premiums

Most homebuyers will pay PMI through monthly premiums that are added to their monthly mortgage bill. This is a manageable way to afford PMI without needing additional cash upfront at closing.

Upfront PMI

Sometimes called a single premium, an upfront PMI requires you to pay all of your PMI as a lump sum at the time of closing. If you move or refinance after paying for PMI up front, you may not receive a refund of the premium.

Lender-paid mortgage insurance

Lender-paid mortgage insurance (LPMI) is sometimes an option available for buyers. This is when a mortgage lender will cover PMI costs in exchange for a higher interest rate. You will need to determine if your monthly costs are less with PMI or a higher interest rate before choosing this option.

Split premium

A split premium allows you to choose a combination of the upfront and monthly options. Putting a large lump of cash toward your upfront PMI will decrease how much monthly PMI you will need to pay.

How much does PMI cost?

The cost of PMI varies based on your loan-to-value ratio (LTV), the lender, your credit score and the type and term of your loan. Generally, the cost of PMI will range from 0.5% to 1% of your entire loan amount per year. According to Freddie Mac, buyers can typically expect to pay $30 to $70 per month for every $100,000 borrowed.

Here’s how you can calculate your PMI costs:

Determine your LTV

This is calculated by dividing your loan amount by the appraised value of the property. For example, if you're buying a house worth $400,000 and put down 5%, or $20,000, you will need to borrow $380,000 and your LTV is 95%.

Determine your PMI rate

Your PMI rate is set by your lender and depends on your LTV, credit score and loan terms. For this example, let’s say your PMI rate is 1%.

Calculate your costs

If you have a $400,000 loan and your PMI rate is 1%, you would pay $4,000 annually, or around $333 per month.

How to avoid paying PMI

Here’s how to avoid paying PMI:

Make a 20% down payment

To avoid paying PMI from the start, you’ll need to put 20% down. If you can’t afford 20% down on the home you’re interested in, you may want to consider waiting to make an offer, searching for a lower-priced home or finding a fixer-upper that has a listing price way below its appraisal value.

Reach 20% equity

The most common way to get rid of PMI is by building your home equity to at least 20%. You can do this by making regular payments on your mortgage, which will gradually reduce the principal balance. Once you've reached this milestone, you can request your lender to cancel the PMI.

Automatic termination

According to the Homeowners Protection Act, your lender must automatically terminate PMI when your mortgage balance reaches 78% of the original purchase price, provided you are up to date with your payments.

Refinancing

If your home’s value has increased significantly, you may be able to refinance your mortgage. This could potentially give you a new loan with an LTV ratio of 80% or less, eliminating the need for PMI.

» MORE: How to get rid of PMI

Is paying PMI worth it?

Having to pay PMI is not the end of the world, and depending on the housing market, you might only have to pay this extra fee for an additional year or two.

“People generally view PMI as an added expense and try to avoid it,” said Joe Salerno, co-founder of Yardsworth, a Los Angeles-based company offering home equity loan alternatives.

“While that’s typically good/conservative advice, putting down less than 20% and accepting PMI does have some benefits,” Salerno said. “First, it might be the only way you can afford your home, and second, it does give you extra leverage. That means that if prices appreciate, you do even better.”

» MORE: Is buying a house a good investment?

FAQ

Bottom line

While it can be frustrating to pay an additional cost on top of your monthly payment, it can be worth paying PMI temporarily if it means getting into a home sooner. And you won’t have to pay PMI for the life of your home loan. Once you build up 20% equity in your home, you can request to have your PMI removed.