What is private mortgage insurance (PMI)?
Private mortgage insurance, also known as PMI, is a type of insurance that protects the mortgage lender in case the borrowers don’t make payments. When you take out a loan to buy a house, you’ll be required to pay PMI (n addition to your mortgage principal and interest) if you make a down payment under 20%. PMI premiums are a small percentage of your total loan amount (less than 2%), and you can eventually stop paying it once you've lowered your loan-to-value ratio.
If you're not familiar with PMI, it might seem puzzling. After all, you probably buy other kinds of insurance like renter's insurance or homeowner's insurance, car insurance, and health insurance. Most of the time, you don't change your financial decisions to avoid paying for insurance. So why would you make a larger down payment just to steer clear of PMI?
To see why people might warn you about paying PMI, it helps to look at how PMI works and how it's different from other insurance products you may have purchased.
PMI is insurance that your lender typically require when you get a conventional mortgage.
PMI benefits your lender and makes it less risky for them to offer you a home loan. But it doesn't make the mortgage any less risky for you. If you fall behind on mortgage payments and the insurer steps in, you're not off the hook. You still have the same obligation to repay your loan as agreed, and you can face very serious consequences - like tanking your credit and losing your home.
PMI is different from many other types of insurance people typically buy. Often, you sign up for insurance to protect yourself in case something bad happens, like health insurance in case you get sick or auto insurance in case your car is damaged or stolen.
But private mortgage insurance is only there to protect your lender - if something causes you to miss a mortgage payment, PMI won't provide any benefit to you.
There are three main types of PMI, which are based on how the borrowers pay for it:
Your lender might let you select the option you want, or they might make that decision for you. Your loan estimate and closing disclosure will both show which way you're paying for PMI.
You can pay your entire premium all at once when you close on the home. This means you have to come up with more cash towards closing costs.
Paying the cost of PMI upfront may feel good, but if you decide to sell your house within a few years, you won't be able to get that money back. On the plus side, you don't have to worry about ongoing premium payments and you can enjoy lower monthly housing costs.
It's most common to pay for PMI through monthly premiums. If you go this route, PMI is added to your monthly mortgage payment.
Paying PMI monthly can be a good option if you don't have a lot of savings to cover the premiums in bulk as part of closing costs. Paying PMI monthly is also a good idea if you may move again before your loan term ends, since you end up paying only a portion of PMI — rather than the total amount required for the life of the mortgage — by the time you sell.
If you want to get a head start on premiums, your lender might let you pay part of PMI upfront and the rest in monthly payments. Talk to your mortgage lender about how the premiums can be divided so you know exactly how much you’ll owe and when.
Your PMI payment is calculated as a percentage of your loan amount and usually ranges from 0.5% to 2% of the amount you're borrowing per year, up until PMI is canceled.
So if you take out a $300,000 mortgage, you're looking at annual PMI premiums of $1,500 on the low end to $6,000 on the high end. In other words, you could be charged around $125 to $500 per month.
The rate for PMI premiums can lower or higher though depending on a few things like:
If the mortgage underwriter deems you a reliable borrower, you'll usually pay a lower rate than someone who seems riskier from the lender's perspective. If you've got a great credit score and you're putting just under 20% down on your mortgage, you'll probably be charged a better rate than someone with spotty credit and a lower down payment. PMI can typically be deducted as mortgage interest on your taxes.
You can stop paying PMI once you’ve unlocked a loan-to-value ratio (LTV) of 80%. LTV is the ratio of how much you owe on the home vs. how much it’s worth. The main way to lower your loan-to-value ratio is to build equity in your home by steadily paying down your mortgage, but your LTV can go down and you can stop paying PMI if your home increases in value or you refinance your mortgage.
Let’s say you buy a house worth $300,000. You take out a $270,000 loan, which means you have LTV of 90%. After a few years, your principal is $240,000, which means your LTV is 80%.
Here are four main ways to get out of paying PMI:
Once you have 20% equity in your home, you can contact your mortgage servicer and ask them to remove PMI. You may be eligible to get PMI canceled at this point if you haven't missed payments.
The date when you're scheduled to reach 20% equity appears on a PMI disclosure form that you get at closing. But if you can't find it, or if you're making an extra-large payment to gain equity faster, you can always call your servicer to find out how close you are to the 20% mark.
Your mortgage servicer will ask you to submit a form and to show that no other creditors have claims on your home. (You might also need to get an appraisal to prove that your property has retained its value.)
→ Learn more about building equity in your home
If you don't ask your servicer to remove PMI, or if you aren't eligible for PMI cancellation at the 20% point, you can wait for automatic PMI removal. Your servicer will automatically end your PMI when you get to 22% equity, as long as you're on track with your mortgage payments. If you're behind on payments then, PMI goes away once you get caught up paying what you owe.
Keep in mind that when you mortgage that doesn't undergo traditional amortization — like a balloon mortgage - it may take longer to lower your LTV and reach 22% equity.
Your equity will naturally increase if the value of your home rises. Home values can appreciate due to market conditions. If it’s a seller’s market and average home prices rise, then your home may be worth more than before. You'll need to get an appraisal to prove your home's new value.
Let's say your home's purchase price was $300,0000. You take out a loan for $270,0000, giving you an LTV of 90% ($270,000/$300,000 * 100). The real estate market shifts and your home is worth $350,000. Now your LTV is 77% ($350,000/$270,000*100). You've gained more equity in your without having to do anything.
PMI has a bad rap with borrowers, and that's understandable given that PMI is for the lender's benefit. Borrowers bear the cost of PMI, but they aren't getting any protection from it. From a borrower's point of view, there really isn't any upside to paying for PMI. Plus, PMI can be a significant expense, potentially adding up to thousands of dollars a year for multiple years. For most people, that's not just pocket change.
But that doesn’t mean you should try to avoid paying PMI at all costs or turn down a potential loans that requires it. People typically make down payments well under 20%, so paying for PMI is a fairly standard part of getting a home loan for the average homebuyer.
Saving up for a 20% down payment isn't realistic for everyone, and it sometimes makes sense to opt for a smaller down payment, accept the cost of PMI, and realize the dream of owning a home, instead of postponing homeownership for decades or giving up on this goal.
→ Learn how much money you should save to buy a home
Even when a 20% down payment is achievable, there are some situations where you might want to make a lower down payment despite needing to pay PMI.
For example, maybe you can afford to put 20% down on a two-bedroom home, but your family is expanding and you're going to need four bedrooms in the near future. You might prefer to make a lower down payment on a larger home - even though it entails paying for PMI - so you have the space you need.
And at times when interest rates are low, it's possible to come out ahead by borrowing a larger share of your home's value and investing your money instead of using it for a down payment. (It can be useful to a mortgage calculator to see what your monthly payments would look like based on how much you put down.)
To decide whether PMI is worth it, you need to weigh the cost of PMI against any advantages of making a smaller down payment, which can be useful under for the following:
Consider talking to a housing counselor or a financial advisor to explore the pros and cons.
The usual way to avoid PMI is to make a 20% down payment when you buy a home. But there are a few alternatives that can work if a down payment of that size is out of reach - or if you just don't want to put that much down.
If you take out a "piggyback loan" - a second mortgage or HELOC — you borrow enough money to bring your down payment up to 20%. Then, you don't owe PMI on your first mortgage because your down payment is large enough. The flip side, though, is that you have an additional and likely more expensive loan to pay back. Depending on the interest rate you're charged, this might not actually save you money. And you'll probably need excellent credit to qualify.
It never hurts to ask. This is a long shot, but if you have exceptionally good credit, a lender might agree to drop this requirement.
With this option, your lender covers the cost of PMI, but they charge you a higher interest rate. This can save you money upfront if you're making smaller mortgage payments, but the downside is that you'll have a higher mortgage rate and that means you might pay more in total over the life of the loan.
If you qualify for a USDA loan or a VA loan, you won't pay PMI and you might not have to make a down payment. You'll still owe a fee that's a percentage of the loan amount, but it could be more affordable than PMI.
→ Learn about different types of mortgages
Mortgage insurance premium or MIP is a version of PMI for FHA loans. You pay MIP to the Federal Housing Administration instead of paying PMI to a private company.
Though their purpose is similar, MIP is different from PMI in a few main ways, including:
MIP has both an upfront premium and an annual premium. Unlike with PMI on a conventional loan, you can't choose just one of these payment routes. However, you can finance the upfront premium and repay it gradually as you pay off your loan.
The cost of mortgage premium insurance doesn't depend on your credit. The upfront premium is typically a flat fee: 1.75% of the loan amount (with exceptions for some refinances and for Hawaiian Home Lands and Indian Lands purchases).
The annual premium can be as low as 0.45% or as high as 1.05% of the loan amount, depending on the length of the loan, how much you're borrowing, and how large your down payment is.
When you take out an FHA loan, you must pay MIP for the entire length of the loan - unless you made a down payment of at least 10%, in which case you pay MIP for 11 years.
While you can ask your mortgage servicer to remove PMI once you reach 20% equity, MIP doesn't offer this option. If you want to stop paying MIP, you could try to refinance your FHA loan to a conventional mortgage.
You usually have to pay for PMI when you're buying a house with a conventional loan and making a down payment of less than 20% of the amount it's appraised for. And you'll likely need to get PMI if you refinance with a conventional loan when your equity is less than 20%.
You're responsible for private mortgage insurance until it is cancelled by your lender automatically or you ask them to waive it once you've achieved 20% equity in your home and have an LTV of 80% or less.
Aside from putting 20% down, you can avoid PMI by rolling it into your closing costs, taking out another loan to pay for premiums, or using a government-backed loan, all of which have their own unique pros and cons.
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