Understanding Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) is unlike most other insurance policies (auto, life, health, etc.). PMI protects the mortgage lender if you stop making payments on your home loan. It does not prevent you from facing foreclosure or a decrease in your credit score if you fall behind on mortgage payments.

PMI is arranged by the lender and provided by a private insurance company. You will not get to choose which company your lender uses, although you may have some control over the terms of your PMI payments.

Who needs it?

You may be required to pay for PMI on a conventional home loan if you can’t make a down payment worth 20% of a home’s purchase price. Mortgage insurance for FHA and USDA loans work a little differently from PMI on conventional mortgages. VA loans include a “funding fee” but do not require mortgage insurance for lendees with less than a 20% down payment.

It is possible to avoid paying for PMI, even without a 20% down payment, but the interest rate on the home loan will be higher. Depending on the lender and other factors, like how long you plan to stay in the home, it can be more or less expensive to pay this higher interest rate than pay for PMI. A tax advisor can tell you if and how paying more in interest or paying PMI will affect your taxes differently.

PMI is also required if you refinance with a conventional home loan and your equity in the home is less than 20% of its value. If you’re not sure how much equity you have in your home, you can look at, or ask your lender for, the amortization table of your loan. Remember that with amortized loans like mortgages, a larger percentage of the first years’ payments goes toward paying off interest than the loan’s principal. So it can take longer to build up that 20% equity than you may think.

PMI can help qualify you for a loan you would not otherwise be able to get. However, it increases the cost of the loan, so you really need to assess your personal budget and ask if you’re buying more house than you can afford in the short and long term.

How do you pay it?

There are several ways to pay for PMI. Ask potential mortgage lenders which options they offer.

  1. Monthly premium – This is the most common method of paying PMI. The premium is added to your monthly mortgage payment. It will be included in the loan estimate when you apply for a mortgage.
      
  2. Up-front premium – This is a one-time payment made at closing. If you make this type of PMI payment and then move or refinance, you might not be entitled to a refund of the paid premium. Sometimes the builder or seller of the home will pay the premium as part of the sale negotiation.
      
  3. Both up-front and monthly premiums – Also called split-premium, this is a combination of the first two.

How much does it cost?

According to Genworth Mortgage Insurance, Ginnie Mae (the Government National Mortgage Association), and the Urban Institute, the average annual cost of PMI ranges from 0.5% to 2.25% of the original loan amount. It also depends on the size of your down payment and credit score: the larger the down payment and the higher your credit score, the less you should have to pay in PMI.

How long do you pay for it?

The length of time you must carry and pay for PMI depends on several factors. Below are the most common ways to stop needing to pay for PMI.

Once your original down payment plus the loan principal you’ve paid off through monthly mortgage payments (called the loan-to-value ratio, or LTV) equals 22% of the home’s purchase price, the lender must cancel the PMI. This is required by the federal Homeowners Protection Act, even if your home’s market value has decreased. Keep in mind, you will need to be current on all mortgage payments.

You can also ask your lender to cancel your PMI when you reach 20% equity in your house. Your lender may place additional requirements on you to release you early from your PMI obligation. This can include being current on all payments, having a satisfactory payment history, not having any additional liens on your property, and/or having a current appraisal to substantiate your home’s value.

Before deciding if taking out a home loan with PMI is right for you, it’s important to know that accumulating enough home equity through regular monthly mortgage payments to get your PMI canceled generally takes about 11 years, according to the Investopedia website.