What is PMI?
Private mortgage insurance (PMI) is a type of insurance that is required when you buy a home with 20% down. PMI is paid by the homeowner but protects the lender in case of foreclosure.
Why would someone pay for PMI when it only protects the borrower? Because PMI allows you to buy a home with 3% down. To avoid PMI, you usually need 20% down – which can take years to save.
It is important to remember that PMI is not always. Many people buy a home with a down payment, pay PMI at the beginning, and get paid off after a few years. Since PMI helps you buy a home and start making money sooner, it often pays for itself over time.
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What is the purpose of private mortgage insurance?
Private mortgage insurance protects your lender from losing money that could exist if you default on your loan and it has to cost you. A general rule of thumb is that if you put 20% down, your lender won’t lose much money on approval. That’s why debt is Less more than 20% down requires PMI as additional security.
If you put 20% down on your home, you will have the same ‘cushion’ as if you had 20% down. At that point, the PMI can be waived and you no longer have to make monthly payments.
How much does PMI cost?
PMI rates vary depending on the loan amount and the amount owed but generally cost between 0.5% and 1.5% of the mortgage each year. Borrowers with a 620 credit score and 3% down (minimum requirements for the same loan) will pay higher PMI rates, while borrowers with higher FICO scores and/or more money down will see reduced rates. A high debt-to-income (DTI) ratio can also raise your home insurance premium.
The annual cost of PMI is divided into installments and added to your mortgage payment. For example, let’s say you have a $300,000 loan. A 0.5% PMI rate means you pay $1,500 per year or $125 per month. A 1.5% rate on the same loan would cost $4,500 a year or $375 a month.
Keep in mind that PMI costs decrease each year you pay off your mortgage because the PMI cost will be paid on a smaller loan. After that, when the loan is paid up to 80% of the value of your home, the PMI can be removed altogether.
When is PMI required?
Almost every type of mortgage requires home insurance if you put down 20%. Conventional loans with 20% down or more are exempt from PMI.
Standard mortgages are mortgages that are not backed by the federal government. Most U.S. mortgages are conventional “conforming” loans, meaning they conform to lending guidelines set by Fannie Mae and Freddie Mac. Conventional loans with less than 20% down almost always require PMI, except for a few programs that have higher interest rates.
Government-backed loans are not guaranteed. Instead of PMI, they charge their own insurance premiums. With an FHA, VA, or USDA loan, you will pay some type of insurance fee regardless of how much you pay.
- FHA loans Mortgage insurance premiums (MIP). There is an initial fee and a monthly fee
- USDA loan charge mortgage insurance (MI). There is an initial fee and a monthly fee
- VA loan pay an upfront fee, called a VA fee. No monthly PMI
The main difference between regular PMI and FHA mortgage insurance is that FHA mortgage insurance is usually for the life of the loan. The same goes for USDA mortgage insurance. In comparison, regular PMI can be waived when you have enough equity in the home.
VA loans are the only loan that does not charge monthly home insurance with a 20% down payment. There is only one fee (“VA fee”) that most people add to their loans.
Is PMI bad?
PMI does not protect the borrower, but they are the ones who must pay. Because of this, PMI often gets a bad rap and many home buyers want to avoid it if they can.
But there is also a big change in the PMI. If you are willing to pay PMI you can buy a home with only 3-5%. This can put you in a home years sooner than waiting to save 20%. And, as home prices rise faster, homeowners earn more than they do on the PMI. So, in a way, the extra money can pay for itself (and then some).
Remember that once you have 20% of your home equity – meaning your loan is down to 80% of your home’s value – you can stop paying PMI. Monthly fees will be waived for good. So you can think of PMI as a short-term investment that yields long-term benefits.
For more information, read: How much does home insurance cost? PMI cost versus profit.
When can I stop paying PMI?
You can stop paying for mortgage insurance when your mortgage is down to 80% of your home’s appraised value. When home prices rise quickly, it may be too soon – maybe a year or two – after you buy your property.
If you want to stop paying PMI when you reach 80% of the loan amount, you must ask the lender to waive it. A new appraisal may be required if your appraisal is based on rapidly increasing home values. Otherwise, PMI will automatically be suspended once your mortgage is paid down to 78% of your home’s value.
To be clear, this applies to regular loans. If you have a government-backed loan from the FHA or USDA, home insurance is usually standard. To get rid of it, you need to pay off your government loan with a private loan when you have at least 20% down. At this point, you can get an equity loan without PMI.
Can I avoid PMI?
You can avoid private home insurance with less than 20% down. But, unless you qualify for a VA loan, it may not be straightforward.
For example, you can get Lender-Paid Mortgage Insurance (LPMI) from other lenders. That may sound good, but there is a catch. Mortgage lenders pay higher interest rates on loans without PMI. And this premium is with you for the life of the loan – unlike PMI, which can be written off over several years.
Piggyback loans are another alternative to home insurance. With a piggy bank, you pay 10%, use a fixed-rate loan for 80% of the home’s value, and pay the remaining 10% with a second mortgage (usually a HELOC). A piggyback loan can save you money in the long run, but it is difficult to qualify for and the arrangements are very complicated. So have a lender walk you through your options if you’re considering this.
Note that some first-time home buyer programs offer special, low PMI rates. Check out the Fannie Mae HomeReady loan and the Freddie Mac Home Possible loan. Some lenders also offer their own PMI free programs. But this only targets specific groups, such as low-income first-time buyers, doctors, teachers, first responders, etc.
Your next steps
PMI may seem boring, but it’s a very useful tool for home buyers. Using a low down payment loan with PMI can get you into a home faster than you think. And remember that PMI is not always; you will be able to remove it.
So before applying for PMI, research your options. Have a lender walk you through the cost and long-term benefits of using PMI. You may find that in the end it is a wise decision.
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