Private Mortgage Insurance: Your Ultimate Guide To How PMI Works

If you are one of those who own payments of less than 20% on a home, it’s essential to understand your options for private mortgage insurance (PMI). While some people simply cannot afford a down payment of 20%, others may prefer to put down a smaller down payment in favor of having more cash on hand for repairs, remodeling, furnishings, and emergencies.

When you buy a home, you pay for homeowners’ insurance to protect the property. However, there is another kind of insurance coverage you might have to pay for. One that doesn’t protect you, but the lender that helped you buy your home.

Private mortgage insurance, commonly called PMI, is a common cost for homeowners who make down payments smaller than 20 percent of the purchase price.

But what is it, and how does it work? This ultimate guide has answers to all your questions about private mortgage insurance, companies, unions even the basic ones like ‘What is the meaning of PMI?’ Stay with us, because this guide is everything you need to know.

Let’s quickly dive in!

What is PMI?

Private mortgage insurance (PMI) could be a sort of protection that routine contract banks require when homebuyers put down less than 20 percent of the home’s purchase cost.

PMI is designed to protect the lender in case 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 that 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.

But you don’t have to pay for PMI, forever. Once you reach 20 percent equity — either through paying down your loan balance over time or through rising home values — you can contact your loan.

How much is PMI?

According to esteemed institutes Genworth Mortgage Insurance, Ginnie Mae, and the Urban Institute, the average annual cost of PMI typically ranges from 0.58% to 1.86% of the original loan amount.

Those midpoints were calculated employing a $241,250 contract — the advance adjust you’d have in the event that you bought a $250,000 domestic and made a 3.5% down payment

At those rates, PMI could cost anywhere from around $1,399 to $4,487 per year, or about $117 to $374 a month.

The cost of private mortgage insurance depends on several factors that include:

1. The size of the mortgage loan

The more you borrow, the more you pay for PMI.

2. Down payment amount

The more cash you put down for the home, the less you pay for PMI.

3. Your credit score

PMI will cost less if you have a higher credit score. Generally, you’ll see the lowest PMI rates for a credit score of 760 or above.

4. The type of mortgage

PMI may cost more for an adjustable-rate mortgage than a fixed-rate mortgage. Because the rate can go up with an adjustable-rate mortgage, the loan is more uncertain than a fixed-rate loan, so PMI is likely higher.

Estimating the cost of PMI before you get a mortgage can help you determine how much home you can afford.

Typically called a “premium,” the PMI cost is added to your monthly mortgage payment. To check the premium on your loan estimate and closing disclosure mortgage documents always go through the “projected payments” section.

Sometimes lenders give you the option to pay the PMI cost in one upfront premium or with a combination of upfront and monthly premiums.

4 Key Questions About PMI

If the idea of paying private mortgage insurance makes you pause and think, you need not worry because it should.

PMI is an avoidable additional cost associated with buying a home. Still, paying PMI can be the right thing to do. It can help you enter a home that is otherwise inaccessible. So before you make the decision to take out a home loan that includes PMI, learn the answers to these four key questions first.

1. Who needs PMI and can I avoid it?

Private mortgage insurance is required by conventional mortgage lenders when the down payment on a home loan is less than 20% of the purchase price, or when you refinance with less than 20% equity. Mortgage insurance is also required for B. FHA loans, such as government-sponsored loans, but with slightly different features.

The easiest way to avoid paying PMI is putting down at least 20% on a home loan. In addition to avoiding PMI, a large down payment also gives you a stronger financial footing and may allow you to borrow less and/or qualify for more affordable loan terms.

On the other hand, saving up 20% of your home’s value can be easier said than done. The median home price in the U.S. was $295,300 as of June 2020, which means you’d need at least $59,060 saved to start house hunting. This may or may not be realistic, depending on your personal financial situation and lifestyle. In high-cost cities, such as San Francisco and New York, where homes can cost more than $ 1 million, you’ll need at least $ 200,000.

Therefore, paying PMI when you can easily afford it is not necessarily a bad thing. But if the PMI is overwhelming your budget, or is causing you to spend significantly more at home than you want, it’s a good idea to avoid it.

2. How much does PMI cost?

Private mortgage insurance costs depend on the lender and the amount you have on the loan in real. PMI is calculated as a percentage of your total loan amount and generally ranges between 0.58% and 1.86%. The larger your loan, the more PMI you will end up paying.

The cost of PMI is also influenced by your loan-to-value ratio (LTV) which represents the amount of borrowing when compared to the total asset value. The more you put it, the less you need to borrow and the higher your LTV. The lower the LTV, the higher the risk of the lender.

As a result, lower LTV often leads to higher PMI costs. For example, if you put 20% down on a home, your LTV should then be 80%. A smaller down payment—and thus,

lower LTV—likely will require you to pay PMI until you reach that 80% mark. The lower your LTV, the higher the risk for the lender, which is why the cost of PMI often increases as your LTV decreases.

Last but not the least, your credit score also can influence the cost of PMI. The higher your score, the less risk you represent to lenders, making it possible to qualify for lower PMI with good credit.

Let’s look at an example of how much PMI can cost:

Say you purchased a home for $500,000 and only put 10% down ($50,000). That means you borrowed a total of $450,000. Your lender charges you a PMI of 1%, for an annual premium of $4,500 or $375 per month.

The good news? PMI is currently tax-deductible. In the past, you could only deduct PMI through 2017. However, due to the Further Consolidated Appropriations Act of 2020, Congress extended the deduction through Dec. 31, 2020, making it possible for you to deduct PMI for tax years 2019 and 2020, as well as retroactively for 2018.

3. How do I pay PMI?

Your lender will arrange PMI through its own network of insurance providers. The terms of the plan, including cost and length of time you’re required to pay it, will be provided to you at closing.

Additionally, you can choose to pay the premium as part of your closing costs, and then annually until you’re no longer required to pay it. Alternatively, you can roll the premium into your loan and make monthly payments on top of your regular loan payments. Keep in mind that if you split up the payments, however, you’ll pay interest on them, too. This can cause PMI to be much more expensive than you realize.

4. How do I get rid of PMI?

Fortunately, there are a few ways to get rid of PMI if you’re required to pay it now. The first is consistently making payments until you have 20% equity in your home—or an LTV of 80%—at which point the lender is required to cancel it. However, this doesn’t happen automatically; you should contact your lender and ensure that PMI is indeed canceled once you meet the qualifications.

Another situation in which you no longer need to pay PMI is if your home value increases and you now have more than 20% equity built up. In this situation, your LTV might reach 80% faster than you were originally required to pay PMI. If that happens, great. You should have your home reappraised, and if you owe less than 80% of the newly appraised value, it’s time to get in touch with your lender to have your PMI canceled. Keep in mind that you are responsible for the costs associated with having your home appraised in this situation.

Finally, if your cash flow has unexpectedly increased and you can afford to pay off your mortgage faster, you may consider doing so—at least for a few months. By making extra payments toward your loan, you can pay down the principal faster and reach an LTV of 80% sooner than originally planned.

Though you probably love the thought of getting rid of PMI as soon as possible, be sure to first crunch the numbers and be sure that’s the best plan of action. Paying extra toward your mortgage should be a better financial move than using the funds for other purposes, such as paying off other high-interest debt.

Private Mortgage Insurance (PMI) Coverage

First, you should understand how PMI works. Suppose you put down 10% and get a loan for the remaining 90% of the property’s value—$20,000 down and a $180,000 loan. With mortgage insurance, the lender’s losses are limited if the lender has to foreclose on your mortgage. That could happen if you lose your job and can’t make your payments for several months.

The mortgage insurance company covers a certain amount of the lender’s loss. For our example, let’s say that percentage is 25%. So if you still owed 85% ($170,000) of your home’s $200,000 purchase price at the time you signed the contract, instead of losing the full $170,000, the lender would only lose 75% of $170,000, or $127,500 on the home’s principal. PMI would cover the other 25%, or $42,500. It would also cover 25% of the delinquent interest you had accrued and 25% of the lender’s foreclosure costs.

If PMI protects the lender, you may be wondering why the borrower has to pay for it. Essentially, the borrower is compensating the lender for taking on the higher risk of lending to you—versus lending to someone willing to put down a larger down payment.

How Long Do You Have to Buy Private Mortgage Insurance (PMI)?

Borrowers can request that their monthly mortgage insurance payments be stopped once the loan-to-value ratio drops below 80%. Once the mortgage’s LTV ratio falls to 78%, the lender must automatically cancel PMI as long as you’re current on your mortgage. What happens when your down payment, plus the loan principal you’ve paid off, equals 22% of the home’s purchase price. This cancellation is a requirement of the federal Homeowners Protection Act, even if your home’s market value has gone down.

Cost of Private Mortgage Insurance (PMI)

The cost of your PMI premiums is dependent on several factors.

• Which premium plan you choose
• If your interest rate is fixed or adjustable
• Your loan term (usually 15 or 30 years)
• Your down payment or loan-to-value ratio (LTV) (a 5% down payment gives you a 95% LTV; 10% down makes your LTV 90%)
• The amount of mortgage insurance coverage required by the lender or investor (it can range from 6% to 35%)
• Whether the premium is refundable or not
• Your credit score
• Any other risk factors, such as the loan being for a jumbo mortgage, investment property, cash-out refinance, or second home

In general, the riskier you look according to any of these factors (usually taken into account whenever you are taking out a loan), the higher your premiums are. And the lower your credit score and the lower your down payment, the higher your premiums.

According to data from Ginnie Mae and the Urban Institute, the average annual PMI typically ranges from .55% to 2.25% of the original loan amount each year. Here are some scenarios:

If you put down 15% on a 15-year fixed-rate mortgage and have a credit score of 760 or higher, for example, you’d pay 0.17% because you’d likely be considered a low-risk borrower.

If you put down 3% on a 30-year adjustable-rate mortgage for which the introductory rate is fixed for only three years and you have a credit score of 630, your rate will be 2.81%. That happens because you’d be considered a high-risk borrower at most financial institutions.

Once you know which percentage applies to your situation, multiply it by the amount you’re borrowing. Then divide that amount by 12 to see what you’ll pay each month. For example, a loan of $200,000 with an annual premium of 0.65% would cost $1,300 per year ($200,000 x .0065), or about $108 per month ($1,300 / 12).

Estimating Rates for Private Mortgage Insurance (PMI)

Many companies offer mortgage insurance. Their rates may differ slightly, and your lender—not you—will select the insurer. Still, you can get an idea of what rate you will pay by studying the mortgage insurance rate card. MGIC, Radian, Essent, National MI, United Guaranty, and Genworth are major private mortgage insurance providers.

Mortgage insurance rate cards can be confusing at first glance. Here’s how to use them.

1. Find the column that corresponds to your credit score.
2. Find the row that corresponds to your LTV ratio.
3. Identify the applicable coverage line. Search the web for Fannie Mae’s Mortgage Insurance Coverage Requirements to identify how much coverage is required for your loan. Alternatively, you can ask your lender (and impress the pants off them with your knowledge of how PMI works).
4. Identify the PMI rate that corresponds with the intersection of your credit score, down payment, and coverage.
5. If applicable, adjust the amount from the adjustment chart that corresponds with your credit score. Let’s say, if you’re doing a cash-out refinance and your credit score is 720, you might add 0.20 to your rate.
6. Now multiply the total rate by the amount you’re borrowing; this is your annual mortgage insurance premium. Divide it by 12 to get your monthly mortgage insurance premium.

Your rate will be the same every month, though some insurers will lower it after ten years. However, that’s just before the point when you should be able to drop coverage, so any savings won’t be that significant.

Types of Private Mortgage Insurance (PMI)

1. Borrower-Paid Mortgage Insurance

The most common type of PMI is borrower-paid mortgage insurance (BPMI). BPMI is an additional monthly fee that is paid with your mortgage payment. After your loan closes, you pay BPMI every month until you have 22% equity in your home (based on the original purchase price).

At that point, the lender must cancel BPMI himself, if you’re current on your mortgage payments. Enough home equity accumulation through regular monthly mortgage payments to get BPMI canceled generally takes about 11 years.

You can also be proactive and ask the lender to cancel BPMI when you have 20% equity in your home. For your lender to cancel BPMI, your mortgage payments must be current. You must also have a satisfactory payment history, and there must not be any additional liens on your property. In some cases, you may need a current appraisal to substantiate your home’s value.

Some loan servicers allow borrowers to cancel PMI sooner based on home value appreciation. Let’s suppose the borrower accumulates 25% equity due to appreciation in years two through five, or 20% equity after year five. In that case, the investor who purchased the loan may allow PMI cancellation after the home’s increased value is proven. That can be done with an appraisal, a broker’s price opinion (BPO), or an automated valuation model (AVM).

Refinancing is another way to get rid of PMI. However, you’ll have to weigh the cost of refinancing against the costs of continuing to pay mortgage insurance premiums. You may also be able to cancel your PMI early by prepaying your mortgage principal so that you have at least 20% equity.

It is worth considering if you’re willing to pay PMI for up to 11 years to buy now. What will PMI cost you ultimately? What will the wait potentially cost you? While it’s true that you might miss out on accumulating home equity while you’re renting, you’ll also be avoiding the many costs of homeownership. These costs include homeowner’s insurance, property taxes, maintenance, and repairs.

The other three types of PMI aren’t nearly as common as borrower-paid mortgage insurance. You might still want to know how they work, in case one of them sounds more appealing, or your lender presents you with more than one mortgage insurance option.

2. Single-Premium Mortgage Insurance

With single-premium mortgage insurance (SPMI), also called single-payment mortgage insurance, you pay mortgage insurance upfront in a lump sum. That can be done either in full at closing or financed into the mortgage.

SPMI gives you the advantage that your monthly payment is lower compared to BPMI. That can help you qualify to borrow more to buy your home. Also, you don’t have to worry about refinancing to get out of PMI. You also need not watch your loan-to-value ratio to see when you can get your PMI canceled.

The risk is that if you refinance or sell within a few years, no portion of the single premium is refundable. Further, if you finance the single premium, you’ll pay interest only till you carry the mortgage. Also, if you don’t have enough money for a 20% down payment, you may not have the cash to pay a single premium upfront.

However, the seller or, in the case of a new home, the builder can pay the borrower’s single-premium mortgage insurance. You can always try negotiating that as part of your purchase offer.

If you plan to stay in the home for three or more years, single-premium mortgage insurance is the best option for you. Ask your loan officer to see if this is indeed the case. And to know if your lender offers it since not all lenders offer single-premium mortgage insurance.

3. Lender-Paid Mortgage Insurance

With lender-paid loan coverage (LPMI), your lender will technically pay the loan coverage top rate. You’ll simply pay for it over the lifestyles of the mortgage withinside the shape of a barely better hobby price.

Unlike BPMI, you can not cancel LPMI. Refinancing may be the most effective manner to decrease your month-to-month charge. Your hobby price will now no longer be lower as soon as you’ve got 20% or 22% fairness. Lender-paid PMI isn’t refundable.

The advantage of lender-paid PMI, despite the better hobby price, is that your month-to-month charge ought to nevertheless be decreased than making month-to-month PMI payments. In that manner, you can qualify to borrow more.

4. Split-Premium Mortgage Insurance

Split-top rate loan coverage is the least unusual place type. It’s a hybrid of the primary sorts i.e. BPMI and SPMI.

Here’s the way it works: You pay a part of the loan coverage as a lump sum at ultimate and element month-to-month. You don’t have to give you as much extra money in advance as you will with SPMI, nor do you boost your month-to-month charge through as much as you will with BPMI.

One motive to pick out split-top rate loan coverage is when you have an excessive debt-to-earnings ratio. When this is the case, growing your month-to-month charge an excessive amount with BPMI might suggest you are no longer qualified to borrow sufficient to buy the house you want.

The in advance top rate may vary from 0.50% to 1.25% of the mortgage amount. The month-to-month top rate may be primarily based totally on the internet mortgage-to-price ratio earlier than any financed top rate is factored in.

As with SPMI, you could ask the builder or vendor to pay the preliminary top rate, or you could roll it into your loan. Split charges can be in part refundable as soon as loan coverage is canceled or terminated.

5. Federal Home Loan Mortgage Protection (MIP)

There is an extra sort of loan insurance. However, it’s miles best used with loans underwritten by way of means of the Federal Housing Administration. These loans are referred to as FHA loans or FHA mortgages. PMI via the FHA is referred to as MIP. It is a demand for all FHA loans and with down bills of 10% or less.

Furthermore, it can’t be eliminated without refinancing the home. MIP calls for a premature charge and month-to-month premiums (commonly delivered to the month-to-month loan note).

Is PMI tax deductible?

At present, private mortgage insurance is tax-deductible. Congress extended the tax deduction for mortgage insurance premiums, which had expired at the end of 2017, through the end of 2020.

The amount paid for private mortgage insurance is treated as mortgage interest on your tax return. For claiming the deduction for the 2020 tax year, the insurance contract must have been issued after 2006.

The amount you can deduct may be eliminated if your adjusted gross income is more than $100,000 ($50,000 if married but filing separately) on Form 1040 or 1040-SR, line 8b.

You can’t deduct mortgage insurance premiums if your adjusted gross income is more than $109,000, or $54,500 if married but filing separately.

When can you stop paying PMI?

Once your mortgage principal balance is less than 80% of the original appraised value or the current market value of your home, whichever is less, you can generally get rid of PMI. Often there are additional requirements, such as a history of timely payments and the absence of a second mortgage.

How do I pay for PMI?

There are several different ways to pay for PMI. Some lenders may offer more than one option, while other lenders do not. Before agreeing to a mortgage, ask lenders what choices they offer.

The most common way to pay for PMI is a monthly premium.

• This premium is added to your mortgage payment.
• The premium is shown on your Loan Estimate. You will get a Loan Estimate when you apply for a mortgage before you agree to this mortgage.
• The premium is also shown on your Closing Disclosure on page 1, in the Projected Payments section.

Sometimes you pay for PMI with a one-time up-front premium paid at closing.

• This premium is shown on your Loan Estimate and Closing Disclosure on page 2, in section B.
• If you make an up-front payment and then move or refinance, you may not be entitled to a refund of the premium.

Sometimes you pay with both up-front and monthly premiums.

• The up-front premium is shown on your Loan Estimate and Closing Disclosure on page 2, in section B.
• The premium added to your monthly mortgage payment is shown on your Loan Estimate and Closing Disclosure on page 1, in the Projected Payments section.

Lenders might offer you more than one option. Ask the loan officer to help you calculate the total costs over a few different timeframes that are realistic for you.

Factors You Should Consider When Deciding Whether to Choose a Loan that Requires PMI

You may be able to cancel your monthly mortgage insurance premium once you’ve accumulated a certain amount of equity in your home. Learn more about your rights and ask lenders about their cancellation policies.

Like other kinds of mortgage insurance, PMI can help you qualify for a loan that you might not otherwise be able to get. But, it may increase the cost of your loan. And it doesn’t protect you if you run into problems on your mortgage—it only protects the lender.

Lenders sometimes offer conventional loans with smaller down payments that do not require PMI. Usually, you will pay a higher interest rate for these loans. Paying a higher interest rate can be more or less expensive than PMI—it depends on several factors, including how long you plan to stay in the home. You may also want to ask a tax advisor about whether paying more in interest or paying PMI might affect your taxes differently.

Borrowers making a low down payment may also want to consider other types of loans, such as an FHA loan. Other types of loans may be more or less expensive than a conventional loan with PMI, depending on your credit score, your down payment amount, the particular lender, and general market conditions.

You may also want to consider saving up the money to make a 20 percent down payment. When you pay 20 percent down, PMI is not required with a conventional loan. You may also receive a lower interest rate with a 20 percent down payment.

Ask lenders to show you detailed pricing for different options so you can see which option is the best deal.

Warning: Private mortgage insurance protects the lender—not you. If you fall behind on your payments, PMI will not protect you and you can lose your home through foreclosure.

Is Having PMI Bad?

PMI isn’t a bad thing in the sense that it’s not putting you or your house at risk. But it’s not a good thing either. PMI means thousands of dollars coming out of your pocket with no benefit to you at all. It’s best to dodge PMI whenever possible.

The only way to avoid private mortgage insurance is to save up a down payment that’s 20% or more of your home price. We get it—saving up that kind of money takes serious determination. After all, 20% of a $250,000 house is $50,000. You need patience and intensity to save for even half that—but you can do it!

If you followed what we teach at Ramsey, you’d be debt-free and have an emergency fund of three to six months of living expenses before shopping for a house. Imagine how much momentum that’d give you to save for a 20% down payment! For more ideas on how to save a big down payment fast, check out our free Saving for a Down Payment Guide.

Another way to help you hit that 20% down payment and avoid PMI is to shop for a less expensive house. That way, you can make your down payment savings go a lot farther! An agent who eats, sleeps and breathes real estate knows where to find the best homes with the lowest prices as soon as they hit the market. For a quick and easy way to find an experienced real estate agent near you, try our Endorsed Local Providers (ELP) program.

Now, if reaching that 20% down payment is simply out of reach for you—unfortunately, you will have to pay for PMI. But don’t worry, there are ways you can eventually have it removed from your mortgage.

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.
• 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 been appreciated since you purchased it, you can contact your lender to request a professional appraisal. According to HomeAdvisor, an appraisal will cost around $340 — 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.

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.

Mortgage insurance costs borrowers money, but it enables them to become homeowners sooner by reducing the risk to financial institutions of issuing mortgages to people with small down payments. You might find it worthwhile to pay mortgage insurance premiums if you want to own a home sooner rather than later for lifestyle or affordability reasons. Adding to the reasons for doing this: Premiums can be canceled once your home equity reaches 80% if you’re paying monthly PMI or split-premium mortgage insurance.

However, you might think twice if you’re in the category of borrowers who would have to pay FHA insurance premiums for the life of the loan. You might be able to refinance out of an FHA loan later to get rid of PMI. On the other hand, there’s no guarantee that your employment situation or market interest rates will make a refinance possible or profitable.