Private Mortgage Insurance: How PMI Works

If you have a installment of less than 20% on your home, you will probably need to buy private mortgage insurance, or PMI. When you make a smaller down payment, lenders tend to treat you as a higher-risk candidate for a mortgageand the PMI requirement protects your borrower in case you default on your loan.

Although PMI makes it possible for prospective homeowners, especially first-time buyers, to qualify for a mortgage with less than 20% off, the monthly premium will add hundreds of dollars to your mortgage payment each month – so make sure you consider this expense when you find out your home purchase budget. PMI is required for conventional loans and loans from the Federal Housing Association, but some types of loansas VA loansdoes not require it.

Here’s everything you need to know about PMI, how it works, when you need it and how much it will cost you over the life of your mortgage.

What is PMI and how does it work?

PMI offers buyers the opportunity to buy a home by using a conventional mortgage loan with less than the required 20% down payment. PMI protects lenders that offer lower repayment financing options. If you are unable to make a 20% down payment, lenders will consider you a more risky lender with a greater chance of defaulting on your mortgage. Should this happen, the borrower can use the sponsored PMI payments you paid by default to recover from their loss.

The price of PMI

Borrowers with PMI usually pay between 0.5% and 1.5% of the loan amount on average each year – or between $ 30 and $ 70 a month per $ 100,000 borrowed, according to Freddie Mac. For example, if you take out a $ 250,000 loan with a 5% down payment, PMI will add between $ 1,188 and $ 3,563 annually – or about $ 100 to $ 300 on your monthly mortgage payment.

How you pay PMI, whether monthly or annually, differs according to the borrower. Some may also allow you to make a partial down payment on closing, which may lower your monthly or annual PMI payments.

How to Include a Low PMI Rate

Credit score: The higher your credit scorethe greater the chance you have of including a lower mortgage interest rate and PMI premium.
Installment: The closer you can get to a 20% down payment, the lower your PMI rate will be and the faster you can get rid of it.
Occupation: Owner-occupied properties get lower PMI rates than rental or investment properties.

When can I stop paying PMI?

PMI is usually no longer required once you have at least 20% equity in your home – either from the down payment of the principal or an increase in the value of your home. In fact, your lender should cancel your PMI as soon as your mortgage balance reaches 78% of your home’s original purchase price.

However, some lenders may have further requirements that you must meet before fulfilling your PMI obligations. This may include making a fixed number of mortgage payments, getting a new assessment or owing less than 80% of your loan principal.

Although this process may differ slightly depending on the borrower, you can usually request PMI cancellation in writing once you have reached the 80% loan-to-value threshold. You must meet specific requirements as set out by the Bureau of Consumer Financial Protection, including:

A record of good payment history
Current loan status (not in default)
The equity should not be subject to a subordinated loan
Proof of value, if requested (achieved through a review)

Borrowers with Fannie Mae or Freddie Mac mortgages have a different threshold for removing PMI if the mortgage is between two and five years old. For these lenders, the equity must be at least 25% before PMI can be terminated.

The benefits of PMI

Although PMI adds an additional expense to your monthly mortgage payments, it can be worth it in some cases. Here are some benefits of PMI:

You can buy a house sooner: For many potential homeowners, high repayment requirements make owning a home unsustainable. With repayment requirements as low as 3%, lenders can buy a home sooner.
You can build wealth faster: Owning a home can help increase your net worth. Buying a home earlier with the help of PMI can also help you build stocks faster, which in turn can help you eliminate PMI sooner.
This is a temporary charge only: Once you have reached an 80% LTV ratio (75% for Fannie Mae and Freddie Mac loans), you can request the removal of PMI. If you do not request it, lenders are expected to remove PMI automatically when you reach 78% LTV.
PMI is currently tax deductible: If you file a detailed tax return, you can currently deduct private mortgage insurance from your tax return until the end of 2021. This tax deduction was revived in January 2021 in the Further Consolidated Budgets Act, 2020 and extended to 2021 in the Consolidated Appropriations Act.

Disadvantages of PMI

While PMI can help you secure a mortgage with a lower installment, there are some disadvantages to consider.

This is an extra premium: No matter how low your PMI interest rate is, you will still pay an extra expense each month.
PMI rates can be high: PMI rates are determined based on your credit score, home occupancy, repayment amount and equity rating. A high PMI rate can increase your monthly mortgage payment by more than you can comfortably afford.
Canceling PMI takes time: You still have to pay PMI until the borrower cancels it at 78% LTV. When requesting cancellation earlier, you will often need to submit a formal request in writing, which may take time to process and remove. You may also need to pay for an assessment if your borrower needs one.

Does All Home Loans Require PMI?

Although PMI is typically only required for conventional mortgages, other specialized mortgage types have their own version of it – with their own set of requirements.

Conventional bandages: If you are depositing less than 20% on a conventional loan, expect to pay PMI. There are a few non-PMI options, but these usually include higher interest rates, which can actually cost you more in the long run.
FHA loans: FHA loans allows you to borrow with as little as 3.5% and have a monthly insurance premium or MIP. Depending on your borrower, your MIP may require prepayment at closing and monthly or annual payments thereafter. Borrowers who make a down payment of 10% or more have to pay MIP for 11 years, while borrowers who pay less than 10% have to pay PMI for the life of the loan.
USDA loans: Although USDA loans does not require an installment, there is a mortgage insurance requirement, with advance and annual fees attached. An upfront fee of 1% of the loan value is due at closing and annual fees of 0.35% are due annually. Although USDA mortgage insurance cannot be canceled, it is typically more affordable than FHA MIP and interest rates tend to be lower.
VA loans: There is no mortgage insurance requirement for VA loans, but borrowers will have to pay a one-time start-up fee between 1.4 and 3.6%, depending on the repayment amount. This fee can typically be rolled into the loan amount.
ARM loans: an ARM, or adjustable-rate connection, may also include PMI. The initial cost may be higher, but you may be able to build up equity faster, so you can remove PMI faster than with a fixed rate bond.

Is PMI worth the cost?

Here’s a consideration. PMI increases your monthly mortgage payment, but may allow you to buy a home with a lower down payment. Note, you may be able to forgo PMI if you get another type of loan, such as a USDA, VA or non-PMI conventional loan – or save for a larger repayment. If you decide to go the PMI route, compare private mortgage insurance rates from a variety of lenders before making a commitment.