What is private mortgage insurance? Do you need it? Find out more about PMI on this article
If you pay less than 20% of the purchase price of your home, you will likely be on the hook for private mortgage insurance (PMI). While insurance rates fluctuate daily, these payments can add up after a while—usually a couple of hundred dollars per month until you build of 22% equity in your home. At this point, lenders are legally required to stop charging PMI premiums.
However, you do have options.
With a little research, you can avoid PMI altogether or have it removed. Here is everything you need to know about private mortgage insurance, from what it is to how much it will cost you to how to have it removed entirely. For our usual audience of mortgage professionals, please share this article with any clients who have questions about private mortgage insurance to get them up to speed.
What is the meaning of private mortgage insurance?
Private mortgage insurance (PMI) is a type of mortgage insurance that you have to pay for a conventional loan when you make a down payment of under 20% of the purchase price of the property. One of the main reasons for PMI is to protect the lender if you are unable to make payments on your home loan, i.e., if you default on your home loan.
Most lenders offer low down payment programs, which allow you to make a down payment of as little as 3%. In order to gain that flexibility, you will have to pay PMI. Lenders need coverage for down payments under 20% of the purchase price because it means that you own a smaller stake in your property. However, you can request to stop paying PMI when you have reached 20% equity in your home. Either way, PMI is usually cancelled by your lender automatically after you reach 22% equity.
How to avoid paying private mortgage insurance
If you would prefer to avoid making private mortgage insurance payments altogether, there may be some options available to you. Let’s take a quick look at four ways to avoid paying PMI:
- A large down payment
- An FHA or USDA loan
- A VA loan
- A piggyback loan
Here is a closer look at each of these options.
1. A large down payment
Firstly, the most common type of PMI is borrower-paid PMI (BPMI), which adds an insurance premium to your regular mortgage payment. If you make a large down payment of at least 20%, you can avoid BPMI altogether, or ask your lender to remove the PMI after you have reach 20% equity in your home. BPMI is automatically removed after you have reach 22%.
2. An FHA or USDA loan
FHA loans (Federal Housing Administration) and USDA loans (US Department of Agriculture) carry mortgage insurance premiums and guarantee fees, respectively, which are both equivalent to mortgage insurance. The one exception is an FHA loan that carries a down payment or equity amount of at least 10%. In that case, you would pay a mortgage insurance premium (MIP) for 11 years.
However, as one US Mortgage Insurers spokesperson points out, MIPs can’t be canceled on loans with down payments of less than 10%. There is also an upfront 1.75% fee on these types of loans, the spokesperson adds. The FHA’s Fiscal Year 2022 Annual Report notes that the average loan-to-value (LTV) ratio for single-family mortgages was 95.01% in 2022, meaning the majority of borrowers purchasing FHA loans put less than 5% down.
3. A VA loan
A VA loan (Department of Veteran Affairs) is the only home loan without true mortgage insurance. VA loans instead have a one-time funding fee that is paid either at closing or built into the loan amount. The size of the funding fee differs depending on the amount of your equity or your down payment and whether it is a subsequent or first-time use. Typically, however, the funding fee is between 1.4% and 3.6% of the loan amount.
4. A piggyback loan
A piggyback loan allows you to make a down payment of about 10% or more and a second mortgage— usually in the form of a home equity line of credit (HELOC) or a home equity loan—is taken out to pay the additional amount required to get you to 20% equity on your initial loan. However, a HELOC may help you avoid PMI payments, but you still make payments on the second mortgage.
However, history has proven that these types of loans can be risky, complex, and expensive, the USMI spokesperson says. Piggybacks performed horribly during the 2008 crisis and seriously complicate loss mitigation due to the potential of two different services and/or investors.
Additionally, second liens usually have origination and closing costs associated with them (potentially title, appraisal, etc.) and the interest rate can be higher than the first lien, because of the increased risk associated with being in the second lien position. What’s more, the USMI spokesperson adds, if it is a HELOC, then you must have equity to tap in order to secure it.
How much does private mortgage insurance typically cost?
While you will have to pay private mortgage insurance if you pay less than 20% of the purchase price of your home, the typical cost of PMI is dependent on a few different factors. There are, however, some general guidelines to determine how much you will be likely to pay in PMI.
Here is an example of PMI in action:
- If you purchase a property for $300,000, you will likely have to make a down payment of 20% of the purchase price—or $60,000—to avoid paying PMI.
- After you have purchased the property, you can usually ask to stop paying PMI after reaching 20% equity in your home.
- Typically, PMI is cancelled automatically after you reach 22% equity.
As with any type of insurance, PMI is based on insurance rates that fluctuate daily. However, typical PMI costs are between 0.1% and 2% of your loan amount each year. To put this into perspective, let’s return to that $300,000 home you just purchased. For that home price, and that PMI cost of 0.1% and 2% per year, you could pay between $1,500 and $3,000 each year on PMI. Using this example, that would mean you would pay between $125 and $250 every month.
When determining how much PMI you will have to pay as part of your regular mortgage payment, your lender will also consider various factors including:
- Down payment amount
- Credit history
- Type of loan
Let’s take a closer look at each to better understand how lenders determine how much private mortgage insurance you will have to pay.
1: Down payment amount
The down payment amount is a significant factor in determining how much private mortgage insurance you will have to pay. Remember, if you make a smaller down payment, you will be seen as a greater risk to the lender. Essentially, this means that the lender could potentially lose a bigger investment if you default on your loan and your property is foreclosed.
Due to this added risk, your lower down payment will mean that your regular mortgage payments will be higher, and it will take more time before you can cancel your PMI. The larger mortgage payment will also make it more difficult to make your mortgage payments, which means you might be charged higher PMI premiums. You can reduce the amount of PMI you have to pay by increasing your down payment, even if it is less than 20%.
2: Credit history
To ensure you have been a responsible borrower in the past, your lender will investigate your credit history. Your credit history is used as an indicator of how reliably (or unreliably) you have repaid borrowed money. For instance, a higher credit score can indicate a few different things, such as:
- You promptly pay your bills
- You avoid maxing out your credit limit
- You borrow only as much money as you can repay
- You consistently make more than the minimum payments on accounts, credit cards, etc.
Since you have proven that you are a responsible borrower who consistently pays back the money you borrow, lenders may charge you less PMI premiums if you have a good credit history and high credit score. If you have a lower credit score, on the other hand, the lender will likely trust you less in your ability to responsibly manage your debt. This may result in your having to pay a higher PMI premium.
3: Type of loan
The amount you have to pay in PMI can also be influenced by your loan type. A fixed-rate loan, for instance, can reduce the amount of risk involved with the loan since the rate will remain constant, which also means consistent mortgage payments for you. If you are seen as less of a risk, your PMI will be lower and, ultimately, you will likely pay less.
On the other hand, adjustable-rate mortgages (ARMs)—loans that fluctuate with the market—carry added risk since it is more difficult to predict your future mortgage payments. In other words, your mortgage insurance rate may be higher with an adjustable-rate mortgage.
But there are two different ways to look at that. Since ARMs usually have lower initial interest rates compared to fixed-rate mortgages, you will likely be able to pay more toward your principal, which builds equity more quickly and reduces the amount of PMI you will have to pay.
How to make PMI payments
To make PMI payments, there are three primary schedules. The options open to you differ between lenders, but typically include the following:
- Monthly: Paying your PMI premiums every month along with your mortgage payment remains the most common payment method. While it adds to the size of your monthly mortgage bill, it also lets you spread the premiums out over the entire year.
- Upfront: This means you can pay the entire premium amount for the year all at the same time. While your mortgage payments will be lower each month, you will have to budget for the bigger annual expense. And if you move throughout the year, you may be unable to get a portion of your PMI refunded.
- Hybrid: You pay some of the PMI upfront and then spread the rest out with monthly payments. The hybrid option is a good choice if you have extra cash early in the year and would like to limit your housing costs each month.
Regardless of which form of PMI payment you choose; it is important to inquire with your lender about the options are available to you. We recommend speaking with a quality mortgage professional, such as those found in our annual Special Report surveys.
When can PMI be removed?
If you already have it, you can remove PMI in a few different ways. Let’s take a look at when you can remove PMI:
- Build equity
- Contact lender once 20% equity is reached
- Get home appraisal
- Refinance your mortgage
Here is a closer look at the different ways PMI can be removed:
1: Build equity
If you build equity in your home over time, your lender is legally required to stop charging PMI premiums. This happens when your balance reaches 78% of the original loan, or you each 22% equity. For Federal Housing Administration (FHA) loans in the US, you can cancel your mortgage insurance premiums if you make a down payment of at least 10% and when you hit the 11-year mark on your repayment schedule.
2: Contact lender once 20% equity is reached
If you contact your lender after you have reached 20% equity, you can speed up that automatic PMI cancellation when your balance reaches 80% of the original loan. You will be able to request to cancel PMI at this point.
3: Get home appraisal
You can reach 20% equity in your home by ways other than paying down your principal over time. If the value of your property has appreciated since you bought it, you can contact your lender to get a professional appraisal, which usually costs around $350. But don’t worry. After months of cheaper payments, you will quickly be able to make that money back.
4: Refinance your mortgage
Another option to remove PMI is to refinance your mortgage, which itself includes a home appraisal. While this process may cost a little more money, it makes sense if your initial mortgage had a higher interest rate.
These are some ways to have PMI removed. As we have seen, there are also avenues that you can take to avoid PMI altogether. Whether paying PMI is the right financial move for you will depend on your financial situation, as is the form of payment, such as how much and when. Because there are many options available, it is important that you ask your lender and conduct your own research. It could end up making the difference of a couple hundred dollars per month—or more.
Have experience with private mortgage insurance? Let us know in the comment section below.