Private mortgage insurance (PMI) is a type of mortgage insurance that homebuyers are typically required to purchase if they have a conventional loan and their down payment is less than 20% of the home’s purchase price. It protects the lender if the buyer defaults on payments.
If a lender requires PMI, it is arranged through a private insurance provider. A borrower will continue to pay PMI until they have gained 20% equity in the home.
PMI is an additional expense that will make your loan more expensive overall. Unfortunately, it is usually unavoidable if your down payment is less than 20%.
How Much Does PMI Cost?
Average PMI costs range from 0.55% to 2.25% of the original loan amount per year.
The amount will vary based on your credit score and your loan-to-value ratio. If you have a higher credit score, your PMI rate will be lower. A higher loan-to-value ratio means greater PMI costs.
Example: Based on the rates listed above, for a $300,000 mortgage, your PMI may cost between $1,650 and $6,750 each year, or $137.50 to $562.50 per month.
How Do I Pay for My PMI?
There are several ways to pay for your PMI. Some lenders offer multiple options while others offer only a single option. Be sure to inquire about what choices are offered by a lender before agreeing to a mortgage.
- Monthly Premium: This is the most common way to pay for PMI. The cost of PMI is rolled into your monthly insurance payment. Before you agree to a mortgage, the premium amount will be shown in your loan estimate.
- Upfront Premium: Another option is a one-time upfront premium paid as part of your closing costs. However, the drawback of this method is that you generally won’t be refunded the amount if you decide to sell or refinance your mortgage.
- Upfront and Monthly Premiums: The third option is a combination of both upfront and monthly premiums. You will pay part of the costs upfront with closing and roll the rest into your monthly mortgage bill. Your lender will determine how much you will pay upfront and how much will be rolled into your monthly payments.
Luckily, you will not have to pay for PMI for the entire duration of your loan, as it is no longer required after 20% equity is reached. There are three ways to cancel your PMI coverage:
- Borrower-Initiated Cancelation: As a borrower, you can request cancelation once you reach 20% equity. The scheduled date where this is expected to occur will be listed on the PMI disclosure form received as part of the closing documents. To finalize the cancelation, you must be sure to request the cancelation in writing, be current on your mortgage payments, have a positive payment history, and confirm you have no junior liens (such as a second mortgage).
- Automatic Termination: If you do not request a cancelation, automatic PMI termination initiates on the date your mortgage balance reaches a 78% loan-to-value ratio(22% equity). Lenders are required by law to cancel PMI by this date. The same conditions for borrower-initiated cancelation must be met.
- Final PMI Termination: With Final PMI Termination, the lender is required to cancel PMI the month after your loan term reaches the midpoint of the repayment schedule, even if the borrower has not yet reached a 78% loan-to-value ratio. For instance, with a 30-year mortgage, the midpoint would be after the 15-year mark. This type of cancelation typically applies to loans with special features, such as a balloon payment or an interest-only period.
How To Avoid PMI Payments
- The easiest way to avoid purchasing PMI is to put 20% down on your home. This will automatically eliminate the requirement.
- There are also some lenders that may offer conventional loans with down payments under 20% that do not require PMI. However, interest rates tend to be higher for these loans. It is necessary to research whether a higher interest rate or paying PMI will be more expensive in the long run.
- Remember, PMI is typically only required for conventional loans. You can consider a Veterans Affairs (VA), Federal Housing Administration (FHA), or United States Department of Agriculture (USDA) loan if you qualify. These types of loans do not require PMI, although FHA loans do require mortgage insurance with different guidelines.
While PMI adds to your mortgage expenses, it can help you secure a loan if you don’t have enough cash to make a 20% down payment. Paying for PMI allows you to borrow more money in exchange for protection for the lender.
Many homebuyers are opting for PMI these days, as the median down payment on a home was 10% in 2017 according to the National Association of Realtors. If you are in the process of buying a property, check to see if purchasing PMI makes sense for your situation.