A question we hear frequently: What is PMI on a mortgage? PMI simply stands for private mortgage insurance, which your lender will require you to pay monthly if you buy a house with less than 20% down. Basically, PMI is insurance that protects the lender if you default, or fail to repay the loan.
Paying PMI on a mortgage enables you to buy a home even if you don’t have access to a lot of cash for the down payment. However, PMI is an added expense for homeowners, so it’s important to understand how much it costs and how to (eventually) get rid of it.
What is private mortgage insurance (PMI) and how does it work?
PMI is insurance coverage required by conventional lenders if you purchase a home with less than 20% down. Loans with smaller down payments are considered riskier, and the insurance protects the lender if you stop making your mortgage payments.
If you buy a home with a down payment of less than 20% and get a conventional mortgage, you’ll be required to pay PMI.
The lender may offer you a few options to pay PMI:
Monthly premiums. Paying monthly is the most common way to pay for mortgage insurance. The PMI premium will be included in your monthly mortgage payment.
One-time, upfront payment. With this option, you pay the entire premium at closing. While you don’t have to pay monthly premiums, you may not get a refund on anything extra you paid if you refinance or sell the house.
A hybrid approach. The lender may allow you to pay some of the PMI premium upfront and spread out the rest of the amount into a monthly premium that’s added to your mortgage payment.
When you shop for a mortgage, the premium amounts will be listed on your loan estimate and closing disclosure.
What’s the difference between PMI, MIP, and homeowners insurance?
If you’re new to homebuying and mortgages, it’s easy to get confused about the different kinds of insurance homeowners deal with. Here are three types of insurance you may come across:
PMI. PMI stands for private mortgage insurance. If you are getting a conventional loan (not through a government program) and your down payment is less than 20% of the purchase price, you’ll have to pay for PMI. The insurance covers the lender if you fail to make your mortgage payments.
MIP. MIP stands for mortgage insurance premium, and it’s required on loans backed by the Federal Housing Administration (FHA). With an FHA loan, you pay MIP rather than PMI. All borrowers with an FHA loan pay both an upfront cost due at closing and a monthly premium. Mortgages backed by the U.S. Department of Agriculture have a similar insurance program, called an annual guarantee fee, which the buyer pays as part of the monthly mortgage payment.
Homeowners insurance. Homeowners insurance is also called property insurance or hazard insurance. It covers your home if it is damaged by fire or other disasters. The lender will require you to buy homeowners insurance so you can afford to repair the home if it’s damaged in a catastrophe or natural disaster. Unlike PMI, which only protects the lender, homeowners insurance protects you, the homeowner, from having to pay for expensive repairs caused by a covered natural disaster or catastrophic event.
How much does PMI cost and how is it calculated?
The cost of mortgage insurance varies based on factors such as the down payment, the borrower’s credit score, and the type of mortgage you have.
The Urban Institute finds that buyers with higher credit scores pay a lower PMI premium. For example, the annual PMI payment on a conventional loan with a 10% down payment ranges from 0.94% of the loan value with a credit score of 639 or lower to 0.28% with a credit score of 760 or higher. Based on those numbers, if you bought a home with 10% down and took out a mortgage for $300,000, your monthly PMI payment would be $70 if your credit score is above 760 and $235 if it’s under 639.
The size of the down payment also affects the cost of PMI. For a $300,000 home with 5% down, making the total home loan $285,000, the average monthly PMI premium would be $274, according to Freddie Mac’s mortgage insurance calculator. If the buyer put 10% down on that same house, the average monthly PMI premium would drop to $176. It would average $71 with a 15% down payment.
Loans That Require Mortgage Insurance
|Type of loan||Cost of mortgage insurance||Equity to remove insurance|
|Conventional||0.2% to 2%*||20%|
|FHA||1.75% upfront MIP, plus 0.45% to 1.05% annual MIP||Annual MIP required for life of loan with less than 10% down; MIP required for 11 years with 10% or more down|
|USDA||1% upfront guarantee fee (USDA’s equivalent of mortgage insurance); .35% annual fee||USDA guarantee fee is charged for the life of the loan|
* Cost varies depending on loan-to-value ratio and credit score.
While VA loans don’t require mortgage insurance, some VA borrowers may have to pay a one-time VA funding fee to offset the cost of the VA loan program.
Once you achieve an 80% loan-to-value ratio, you become less of a risk to lenders as you have a store of equity in the property. Multifamily properties are a bigger risk, so lenders require a 70% LTV before dropping mortgage insurance.
How can I avoid PMI?
The best way to avoid PMI is to make a 20% down payment when you purchase a house. If you don’t have that much money saved, you may be able to raise the money by:
- Asking family members to gift you some money to use toward the down payment.
- Finding a local down payment assistance program.
Another option to avoid PMI is to get a government-backed loan that doesn’t require mortgage insurance, such as a VA loan for qualified military borrowers or a USDA loan for rural buyers. However, these loans have other fees that serve a similar purpose as mortgage insurance. A VA loan requires a funding fee to offset the program cost to U.S. taxpayers, and a USDA loan requires a guarantee fee of 1% of the loan upfront and 0.35% annually.
Even if you can’t afford to put 20% down, try to avoid making the lowest down payment for a conventional loan. Remember, the lower the down payment amount, the higher your PMI premiums.
How can I remove PMI if I already have a mortgage?
The Homeowners Protection Act of 1998, also called the PMI Cancellation Act, sets out the rules for when the lender must cancel PMI for a conventional loan.
You can ask your loan servicer to cancel your PMI when you have reached 20% equity in the home, according to the loan’s amortization schedule and the payments you’ve made on the loan.
To request cancellation of PMI you must:
- Make the request in writing.
- Be current on your payments.
- Have no liens, including a second mortgage, on the home (this is only required by some lenders).
If you don’t ask your lender to cancel your PMI, the lender is required to automatically cancel the insurance when you’ve made the scheduled payments needed for your mortgage balance to reach 78% of the original value of your home. In other words, you have 22% equity in the home at its original value.
You build equity in a home by making payments on the mortgage, which reduces the principal. Your equity also grows when the home’s value appreciates due to improvements you’ve made or increased real estate prices in your neighborhood. You may have 20% equity due to home-price appreciation before you’re scheduled to reach it on the amortization schedule.
You can ask the lender to accept a new appraisal as proof that you’ve reached 20% equity and cancel PMI.
Another option to eliminate PMI is to refinance if you think you have at least 20% equity in the home. Compare current interest rates and monthly payments with what you’re paying now to determine if you’d save money by refinancing.
If you have an FHA loan and put down 10% or more, your annual mortgage insurance premiums will stop after 11 years. If you put down less than that amount, you’ll pay the annual premiums for the life of the loan. The only way to eliminate FHA MIP in the latter scenario is to refinance into a conventional loan once you reach 20% equity.
Ready to find out more about the costs of homeownership? Talk to a local Finance of America Mortgage Advisor today.