What is PMI? Guide to how private mortgage insurance works

When you buy a home, you’ll pay for homeowners’ insurance to protect the property. However, you might also pay for another kind of insurance coverage — one that doesn’t protect you, but instead protects the lender that helped you buy your home. Private mortgage insurance, commonly shortened to PMI, is a common cost for homeowners who made a down payment smaller than 20 percent of the home’s purchase price.

What is PMI?

Private mortgage insurance (PMI) is a type of insurance that conventional mortgage lenders require when homebuyers put down less than 20 percent of the home’s purchase price.

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PMI is designed to protect the lender in the event that the homeowner defaults on the loan. While it doesn’t protect the homeowner from foreclosure, it does allow prospective homebuyers to become homeowners even if they can’t afford a 20 percent down payment. If your lender determines you’ll need to pay PMI, it will coordinate with a private insurance provider, and the terms of the insurance plan will be provided to you before you close on your mortgage.

If you’re paying for PMI, that cost won’t stay with you forever. Once you’ve reached 20 percent equity — either through paying down your loan balance over time or through rising home values — you can contact your loan servicer about removing PMI from your mortgage. Servicers must terminate PMI on the date that your loan balance is scheduled to reach 78 percent of the home’s original value.

How much does PMI cost?

The average range for PMI premium rates is 0.58 percent to 1.86 percent of the original amount of your loan, according to the Urban Institute. Freddie Mac estimates most borrowers will pay $30 to $70 per month in PMI premiums for every $100,000 borrowed. How much you will pay for PMI depends on two key factors:

• Your loan-to-value (LTV) ratio – How much you put down will impact how much you’ll pay for PMI. For example, if you put down 5 percent, your LTV ratio would be 95 percent. If you put down 15 percent, your LTV ratio would be 85 percent. When you can only make a small down payment, the lender is assuming a bigger risk, and your PMI payments will be higher to account for that risk.
• Your credit score – Your credit history and corresponding credit score play a major role in the cost of PMI. For example, consider the Urban Institute’s example of someone buying a $250,000 property with a 3.5 percent down payment. With an excellent FICO score of 760 or greater, the monthly mortgage payment including the insurance is $1,164. For a buyer with a credit score between 620 and 640, those monthly payments are $1,495 – a reflection of a significantly higher PMI charge.

Here’s a look at how PMI might play out based on how much you put down, according to the Freddie Mac mortgage insurance calculator and the Bankrate mortgage calculator. These examples assume a $329,000 purchase price and a 3.25 percent interest rate, and do not account for homeowners insurance and property taxes.

Different types of PMI

There are a few options for private mortgage insurance:

Borrower-paid mortgage insurance

With borrower-paid mortgage insurance, the premiums are part of your monthly bill. This will also include the principal balance, interest charges and other costs such as property taxes. The funds are then disbursed each month to the insurer.

You’ll see an indication each month of a “special payment,” which is simply an explanation that the money was paid out.

With borrower-paid mortgage insurance, you may be able to get the payments removed after meeting specific requirements, such as reaching 20 percent equity, 78 percent loan-to-value, or finishing half of your payment term.

Lender-paid mortgage insurance

Lender-paid mortgage insurance might sound appealing, but make no mistake: You’ll still pay for the coverage. Instead of seeing that premium as a line item, you’ll likely pay a higher interest rate on the mortgage and/or shell out additional origination fees for the loan.

Another drawback is that you can’t get lender-paid PMI canceled in the same way that you can with borrower-paid insurance. Your main path to getting out of lender-paid PMI is to refinance.

Single-premium mortgage insurance

Instead of dividing up payments into regular installments each month, single-premium PMI bundles the entire cost of the insurance into one payment.

Depending on the terms of the loan, you can either pay this in full at closing or roll the amount into the loan for a higher balance.

If you pay it upfront, you’ll get the benefit of lower monthly payments. However, if you sell your home shortly after buying it, you might wind up worse off than if you’d just paid PMI monthly.

Also consider the fact that if you’re struggling to make a 20 percent down payment, you may not have the cash to afford a large, upfront insurance payment.

Split-premium mortgage insurance

In a split-premium PMI arrangement, you’ll pay a larger upfront fee that covers part of the costs to then shrink your monthly payment obligations.

This combines the pros and cons of single-premium and borrower-paid PMI. You need some cash, but not as much, to pay the upfront premium. You then benefit from lower monthly costs.

Split-premium mortgage insurance can also be helpful if you have a higher debt-to-income ratio. It lets you lower your potential mortgage payment to avoid pushing your DTI too high to qualify.

FHA mortgage insurance

This type of mortgage insurance comes with an FHA loan. It involves an upfront payment and then annual mortgage insurance premiums (MIP), which can’t be canceled in most circumstances.

To get out of FHA mortgage insurance without refinancing, you’ll have to wait 11 years. And even in that case, the insurance will only be canceled if your initial down payment was 10 percent or more.

How do I make PMI payments?

There are three primary schedules for making PMI payments. The options available to you will vary depending on your lender.

• Monthly: The most common method is paying PMI premiums monthly with your mortgage payment. This boosts the size of your monthly bill, but allows you to spread out the premiums over the course of the year.
• Upfront: Another option is an upfront PMI payment, meaning you pay the full premium amount for the year all at once. Your monthly mortgage payment will be lower, but you need to be ready for that larger annual expense. Additionally, if you move sometime in the year, you might not be able to get part of your PMI refunded.
• Hybrid: The third option is a hybrid one: paying some upfront and some each month. This can be useful if you have extra cash early in the year and want to limit your monthly housing costs.

Ask your lender if you have a choice for your payment plan, and decide which option is best for you.

Do all lenders require PMI?

As a rule, most lenders require PMI for conventional mortgages with a down payment less than 20 percent. However, there are exceptions to the rule, so you should research your options if you want to avoid PMI.

For example, there are low down-payment, PMI-free conventional loans, such as PMI Advantage from Quicken Loans. The lender will waive PMI for borrowers with less than 20 percent down, but also bump up your interest rate, so you need to do the math to determine if this kind of loan makes sense for you.

Some government-backed programs don’t charge mortgage insurance. For example, if you’re eligible, VA loans don’t require it. This can be helpful for homebuyers who don’t have enough saved up to make a large down payment.

FHA loans require their own mortgage insurance, though the rates can be lower than PMI. However, you won’t have an option to cancel the insurance even after you reach the right equity threshold. In the long term, this can be a more expensive option. Your credit score won’t affect the insurance rate for FHA loans, though it could be higher if you put down less than 5 percent.

Is there any advantage to paying PMI?

Paying PMI comes with one major benefit: the ability to buy a home without waiting to save up for a 20 percent down payment. Single-family home prices are historically high, sitting at an average of $410,600 in July 2022, according to the National Association of Realtors. A 20 percent down payment at that price would be more than $82,000, which can seem like an impossible figure for many first-time homebuyers.

Instead of waiting while saving, paying PMI allows you to stop renting sooner. Homeownership is generally an effective long-term wealth-building tool, so owning your own property as soon as possible allows you to start building equity sooner, and your net worth will expand as home prices rise. If home prices in your area rise at a percentage that’s higher than what you’re paying for PMI, then your monthly premiums are helping you get a positive return on your investment on your home purchase.

Is PMI tax-deductible?

The government reinstated the ability to deduct private mortgage insurance premiums from your taxes in 2020. That benefit is available again in 2022; however, the benefit begins to phase out after your adjusted gross income reaches $109,000. You should determine if itemizing your deductions and including your PMI is greater than taking the standard deduction.

How to stop paying PMI

You can remove private mortgage insurance in the following ways:

• Build equity in your home over time. Your mortgage servicer is legally required to stop charging PMI premiums once your balance hits 78 percent of the original loan. (Note, this does not apply to FHA loans. You can only cancel FHA MIP if you put down at least 10 percent on your home and when you reach the 11-year mark in your repayment schedule.)
• Contact your servicer when you have 20 percent equity. You can press fast-forward on that automatic PMI cancellation when your balance reaches 80 percent of the original loan. At this point, you can request to cancel PMI.
• Get your home appraised. Reaching that magic 20 percent equity marker doesn’t just involve paying down your principal over time. If your home’s value has appreciated since you purchased it, you can contact your lender to request a professional appraisal. According to HomeAdvisor, an appraisal will cost around $350 — a small price that can quickly be recouped after a few months of cheaper payments.
• Refinance your mortgage. Refinancing your mortgage is another option that will include an appraisal. This process costs quite a bit more, but it can make sense if your original mortgage had a high interest rate. Use Bankrate’s refinance calculator to estimate if refinancing is the right move for you.

How to avoid paying PMI?

To avoid PMI for most loans, you’ll need at least 20 percent of the home’s purchase price set aside for a down payment. For example, if you’re buying a home for $250,000, you need to be able to put down $50,000.

Another strategy is a piggyback mortgage. With a piggyback loan, you’d actually get two separate mortgages, one for 80 percent of the home’s value and one for 10 percent. You’d make a 10 percent down payment from your savings, and use the smaller of the two loans to complete the 20 percent down payment.

The upside of this strategy is avoiding PMI, but a piggyback mortgage means having two loans and two monthly payments to make, so consider this option carefully. Some piggyback loans also have shorter terms than the primary mortgage, so your monthly payments will be higher.

You can also find a lender that offers lender-paid PMI. In this scenario, the lender will make the PMI payments. However, the loans usually have higher interest rates.

Another option is to look for loans with no PMI requirements. Some loan programs, such as VA loans, have no PMI payments. Individual lenders may also offer mortgage programs that let you avoid PMI, such as programs for low-income buyers, or people in specific professions such as teaching or medicine.

Bottom line

Private mortgage insurance (PMI) adds to your monthly mortgage expenses, but it can help you get your foot in the homeownership door. When you’re buying a home, check to see if PMI will help you reach your real estate goals faster. Don’t agree to a mortgage without comparing offers from at least three different lenders, though — that way you can try to get the best rate and terms for your specific financial situation.