Traditionally, homebuyers would pay 20% or more of the home’s purchase price as a down payment and fund the remaining 80% with a conventional home. However, if you would rather purchase a home sooner rather than wait to save up enough for a 20% down payment, a lower down payment may be an attractive option for you. And this is where private mortgage insurance (PMI) comes in.
PMI is a tool that makes it possible for conventional-loan borrowers to make a down payment of less than the traditional 20%.
In this article, you will get answers to common PMI questions, including:
- What is PMI insurance and how does it work?
- How much does PMI cost?
- What factors affect a borrower’s PMI requirements?
- Are there ways to avoid or terminate PMI?
What Is PMI and How Does It Work?
PMI is a type of insurance that protects a mortgage lender in case the borrower defaults on their payments. In other words, if a borrower fails to make their mortgage payments requiring the lender to foreclose, their PMI policy helps compensate the lender in the event there is a loss upon the sale of the property.
The purpose of PMI is to provide extra protection for the lender so that they can accept the risk of lending to borrowers who make a down payment of less than 20%. With PMI, well-qualified borrowers can potentially get approved for a conventional home loan with a down payment as low as 3% to 5%.
Here’s how PMI works: The borrower pays for the policy. This could be done with an upfront fee, a monthly premium or a combination of both. If the borrower defaults on their loan, the insurance policy pays out to the lender if there is a loss after the foreclosure process is completed. It's important to note that having PMI does not protect the borrower. Failing to make mortgage payments can still impact the borrower’s credit score and can still result in foreclosure, even if the borrower has PMI.
PMI only applies to conventional loans, which are any loans that are not backed by the U.S. government. Some government-backed loan types have their own forms of mortgage insurance, which is different from PMI.
How Much Is PMI?
The cost of PMI varies from one borrower to the next, depending on a range of factors (which are covered in the next section). For reference, the average cost of PMI ranges from 0.58% to 1.86% of the original loan amount per year. At those rates, PMI on a $400,000 home with a 3% down payment would cost $2,250 to $7,217 per year or $187.50 to $601 per month.
Factors that Influence Your Private Mortgage Insurance Requirements
There are three primary factors that influence the PMI requirements and costs for any given borrower:
- Credit History. A higher credit score may reduce the need for PMI or reduce the cost of PMI.
- Down Payment. A higher down payment may reduce the need for PMI or reduce the cost of PMI.
- Lender Policies. PMI requirements may vary by lender.
How to Avoid PMI
Here are a few options for avoiding PMI:
- Make a Large Down Payment. PMI is not required with a down payment of 20% or more. Borrowers who do not have this much cash available could research down payment assistance programs or ask family members to gift the money needed for the higher down payment.
- Choose a Government-Backed Loan. Government-backed loans like FHA, USDA or VA Loans do not require PMI. They do, however, have similar fees associated with them, so borrowers will need to compare the cost of each mortgage type to decide which is the right fit for them.
- Ask Your Lender About Other Possibilities. Your lender may be able to offer an alternative to PMI, such as a higher interest rate option (which is sometimes offered as “lender-paid PMI”) or a “piggyback” loan, which is a second mortgage.
How to Get Rid of PMI (If You Already Have It)
As long as payments are current (with no payment more than 30 days late in the last 12 months), your loan servicer should automatically terminate the PMI once you have paid down the principal of the loan to the point where the remaining loan balance is 78% of the original purchase price. You can monitor your mortgage account by reviewing your monthly statements to confirm that your PMI is dismissed at this 78% point. It is important to note that your property must be worth at least the original purchase price to remove the PMI.
You could also request a PMI cancellation in writing from your loan servicer once the principal balance of the loan is paid down to the point where the remaining loan balance is 80% of the current market value of the property. This allows you to take advantage of rising home values from appreciation and/or home value increases from renovation work, as well as the decreasing loan balance from having made mortgage payments over time. An appraisal or valuation may be required to confirm the value of the property.
Your servicer may have additional requirements to cancel the PMI at this point, such as strong payment history and/or a home appraisal to confirm the current market value of the property.
PMI Insurance FAQs
How Is PMI Calculated?
The cost of PMI depends on factors such as your down payment amount and credit score. The larger the down payment and the higher the credit score, the less PMI costs.
When Can I Stop Paying PMI?
You may stop paying PMI once the principal balance of the loan is paid down to 78% of the purchase price, assuming that the property is worth at least as much as the original purchase price. An appraisal or valuation can be used to confirm the current value. You could also request a PMI termination when the remaining loan balance is 80% (or less) of the current market value of the property. Confirm with your lender that the PMI has been canceled or terminated before stopping PMI payments.
Is PMI the Same as Homeowner’s Insurance?
No. PMI provides some protection to the lender from a borrower's default. Homeowner’s insurance provides some protection for the homeowner in the event that the property is damaged or if someone is injured on the property.
What’s the Difference Between PMI and Mortgage Insurance Premiums (MIP)?
PMI is for conventional loans. MIP is a similar tool, but it's used with FHA Loans.
What’s the Difference Between PMI and Mortgage Protection Insurance (MPI)?
PMI offers some protection for the lender if the borrower defaults. MPI (sometimes called “mortgage life insurance”) may provide protection for the homeowner by covering mortgage payments in the event of the insured’s death.
The Bottom Line
PMI can be a useful tool for homebuyers who are unwilling or unable to put 20% down on a home. A PMI mortgage provides a path to homeownership for those who might not otherwise qualify for a home loan. However, there are financial considerations to make before accepting a loan with PMI. Therefore, it is wise to discuss your options with a reputable lender.