Private Mortgage Insurance: How PMI Works

If you do a down payment less than 20% on your home, you’ll likely need to purchase private mortgage insurance, or PMI. When you make a smaller down payment, lenders tend to consider you as high risk mortgage applicantand the PMI requirement protects your lender in case you default on your loan.

Although PMI allows prospective homeowners, especially first-time buyers, to qualify for a mortgage with less than 20% down, the monthly premium will add hundreds of dollars to your mortgage payment each month—so be sure to get given that expense when you find out your home purchase budget. PMI is required for conventional and FHA loans, but some types of loanslike VA Loansthey don’t require it.

Here’s everything you need to know about PMI, how it works, when you need it, and how much it will cost you over the life of your mortgage.

What is PMI and how does it work?

PMI offers buyers the opportunity to purchase a home using a conventional mortgage loan with less than the required 20% down payment. PMI protects lenders who offer financing options with lower down payments. If you can’t make a 20% down payment, lenders consider you a riskier borrower with a higher chance of defaulting on your mortgage. If that happens, the lender could use the escrow PMI payments you paid until the default to recoup some of your loss.

The cost of PMI

PMI borrowers typically pay between 0.5% and 1.5% of the loan amount each year on average — or between $30 and $70 per month per $100,000 borrowed, according to Freddie Mac. For example, if you take out a $250,000 loan with a 5% down payment, PMI will add between $1,188 and $3,563 per year — or roughly $100 to $300 to your monthly mortgage payment.

How you pay PMI, whether monthly or annually, varies by lender. Some may also allow you to make a partial down payment at closing, which can lower your monthly or annual PMI payments.

How to lock in a low PMI rate

  • Credit rating: The higher your credit ratingthe better your chance of locking in a lower mortgage rate and PMI premium.
  • First payment: The closer you can get to a 20% down payment, the lower your PMI rate will be and the faster you can get rid of it.
  • Occupation: Owner-occupied properties receive lower PMI rates than properties for rent or for investment.

When can I stop paying PMI?

PMI is usually no longer required once you have at least 20% equity in your home – whether from paying down the principal or increasing the value of your home. In fact, your lender is required to cancel your PMI once your mortgage balance reaches 78% of the original purchase price of your home.

However, some lenders may have additional requirements that you must meet before you can fulfill your PMI obligations. These can include making a certain number of mortgage payments, getting a new appraisal, or owing less than 80% of the loan principal.

While this process can vary slightly from lender to lender, you can usually request a PMI cancellation in writing once you reach the 80% loan-to-value threshold. You must meet specific requirements set forth by the Consumer Financial Protection Bureau, including:

  • Record of good payment history
  • Current loan status (not in default)
  • The capital must not be subject to a subordinated loan
  • Proof of value if requested (achieved by assessment)

Borrowers with Fannie Mae or Freddie Mac mortgages have a different PMI elimination threshold if the mortgage is between two and five years old. For these borrowers, equity must be at least 25% before PMI can be terminated.

The benefits of PMI

Although PMI adds additional costs to your monthly mortgage payments, it can be worth it in some cases. Here are a few benefits of PMI:

  • You can buy a home earlier: For many potential homeowners, high down payment requirements make home ownership out of reach. With down payment requirements as low as 3%, borrowers can buy a home sooner.
  • You can build wealth sooner: Owning a home can help increase your net worth. Buying a home earlier with PMI can also help you build equity faster, which in turn can help you eliminate PMI sooner.
  • This is a temporary price only: Once you reach an 80% LTV ratio (75% for Fannie Mae and Freddie Mac loans), you can request a PMI waiver. If you don’t request it, lenders are required to automatically remove PMI when you reach 78% LTV.
  • PMI is currently tax deductible: If you file an itemized tax return, you can currently deduct private mortgage insurance on your tax return until the end of 2021. This tax break was reinstated in the Supplementary Consolidated Appropriations Act of 2020 and extended through 2021 in the Consolidated Appropriations Act. credits in January 2021.

Disadvantages of PMI

While PMI can help you secure a mortgage with a lower down payment, there are some downsides to consider.

  • This is an additional premium: No matter how low your PMI interest rate is, you’ll still be paying an additional expense each month.
  • PMI rates may be high: PMI rates are determined based on your credit score, home occupancy, down payment amount and equity appreciation. A high PMI rate can raise your monthly mortgage payment by more than you can comfortably afford.
  • Canceling PMI takes time: You are still required to pay PMI until the lender cancels it at 78% LTV. When you request cancellation early, you will often need to make a formal request in writing, which can take time to process and remove. You may also have to pay for an appraisal if your lender requires one.

Do all home loans require PMI?

Although PMI is usually only required for conventional mortgages, other specialist types of mortgages have their own version of this – with their own sets of requirements.

  • Conventional mortgages: If you put less than 20% down on a conventional loan, expect to pay PMI. There are some non-PMI options, but they usually come with higher interest rates, which can actually cost you more in the long run.
  • FHA Loans: FHA Loans allow you to borrow with only 3.5% down and have a monthly insurance premium or MIP. Depending on your lender, your MIP may require a down payment at closing and monthly or annual payments thereafter. Borrowers who put down 10% or more must pay MIP for 11 years, while borrowers who put down less than 10% must pay PMI for the entire life of the loan.
  • USDA Loans: Although USDA loans no down payment required, mortgage insurance required, with upfront and annual fees. An upfront fee of 1% of the loan value is due at closing and annual fees of 0.35% are due annually. Although USDA mortgage insurance cannot be canceled, it is usually more affordable than FHA MIP and interest rates are usually lower.
  • VA Loans: There is no mortgage insurance requirement for VA loans, but borrowers will have to pay a one-time origination fee of between 1.4% and 3.6%, depending on the amount of the down payment. This fee can usually be included in the loan amount.
  • ARM Loans: ARM, or adjustable rate mortgage, may also include PMI. The upfront cost may be higher, but you may be able to build equity faster, allowing you to eliminate PMI faster than with a fixed rate mortgage.

Is PMI worth the cost?

There is a trade-off here. PMI increases your monthly mortgage payment, but it can allow you to buy a house with a lower down payment. With that in mind, you may be able to forgo PMI if you get a different type of loan, such as a conventional USDA, VA, or non-PMI loan — or save for a larger down payment. If you decide to go the PMI route, compare private mortgage insurance rates from different lenders before committing.

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