You may be able to buy a home with a low down payment, but it could cost you in the form of private mortgage insurance, or PMI.
If you’re considering a loan that requires private mortgage insurance, you’ve got company. Over the past few years, nearly one in five new conventional loans carried PMI, according to a 2021 study of mortgage data from the Urban Institute. The good news is that private mortgage insurance doesn’t have to last forever. You may be able to cancel PMI after you gain a certain amount of equity in your home, or avoid it all together if you’re able to take the time to build up a big enough down payment.
Let’s go over what PMI is, how it works and how you pay it.
What is PMI?
Private mortgage insurance, commonly referred to as PMI, is a special form of protection for lenders that provide conventional loans. It’s an insurance you pay as the borrower, but it covers your lender’s losses if you fail to make your monthly payments. You usually pay the premiums for this type of insurance as part of your monthly bill.
Private mortgage insurance is often required on loans where you put down less than 20% of the purchase price.
Mortgage insurance vs. homeowners insurance
While these two products may seem similar, they work very differently. Mortgage insurance protects your lender and only your lender. Homeowners insurance can help protect you and your home, as well as your lender’s investment.
Mortgage insurance pays your lender if you default on your loan, while homeowners insurance pays to repair or replace your home if it’s damaged in a fire, burglary or other event as described in the policy.
Your lender will likely require you to carry homeowners insurance, meaning you may have no choice but to pay for both types of policies.
How much does PMI cost?
The cost of private mortgage insurance can depend on the purchase price of the house, the down payment you made, the type of interest rate, the length of the loan and your credit.
The Federal Home Loan Mortgage Corporation (known as Freddie Mac) estimates a typical cost for PMI at between $30 and $70 a month per $100,000 borrowed.
Different types of PMI
There are a few different types of private mortgage insurance. Here’s a look at some of the more common ones.
- Borrower-Paid Mortgage Insurance — This is your standard PMI, with premiums paid by the homeowner typically through monthly installments. You may be able to cancel BPMI once you reach a certain amount of equity in the home.
- Single-Premium Mortgage Insurance — With this option, you make just one large payment for your mortgage insurance. This payment may be due at closing, or you may be able to finance your single-premium mortgage insurance into your loan rather than pay it in cash. If you sell or refinance, you likely won’t be able to get any sort of refund for what you paid.
- Split-Premium Mortgage Insurance — This is a cross between single-premium mortgage insurance and traditional borrower-paid mortgage insurance. You’ll pay a sum upfront, and then make monthly PMI payments for a period of time. These monthly payments will be lower because of the upfront premium.
- Lender-Paid Mortgage Insurance — These policies have premiums paid by the lender, not you as the homeowner. However, these policies can’t be canceled, and you’ll generally pay a higher interest rate for the life of the loan under this arrangement.
Is FHA Mortgage Insurance PMI?
If you’ve looked into FHA loans, you may have noticed that this program also requires mortgage insurance in most cases. But this is not considered private mortgage insurance because your premiums are paid to the Federal Housing Administration.
FHA insurance functions similarly to PMI, protecting the lender in case you default on your payments. You’ll pay an upfront mortgage insurance premium, as well as annual insurance premiums paid in monthly installments as part of your monthly mortgage payment.
The premium you pay is not dependent on your credit. Insurance for an FHA mortgage is paid for either 11 years or the full term of the loan depending on the loan-to-value ratio and whether you choose a 15-year or 30-year loan.
How do I make PMI payments?
In most cases, your PMI will be included as part of your monthly mortgage payment. It may be part of the escrow payment you make each month, in addition to your principal and interest. The escrow account may include other items like homeowner’s insurance and taxes, as well.
You’ll know what this payment will be before you close on your loan, since the private mortgage insurance payment is included as part of your loan estimate and closing disclosure.
Can I avoid or cancel PMI?
Yes, you can avoid PMI, and if you must pay for it, you can often cancel it down the line. One way to avoid private mortgage insurance is to make a down payment of 20% or more. PMI is typically only required on conventional mortgages where you make less than a 20% down payment.
You may also be able to avoid PMI by using two loans to buy your home — a first mortgage that covers 80% of the cost, and a second mortgage or other loan that covers the rest. You’ll want to crunch all the numbers and take a hard look at your budget before you sign up for two mortgages.
Under federal law, you’re also able to cancel your PMI when you achieve reach certain milestones on your mortgage. For example, you can request that your lender cancel PMI when your monthly payments are scheduled to reduce the loan balance to 80% of the original value of the home.
If you’ve made additional payments toward your mortgage, you can request PMI cancellation ahead of schedule, whenever your loan is paid down to 80% of the value. If you don’t request cancellation, your PMI must automatically be canceled when you are scheduled to pay down your loan to 78% of the original value of the home.
What’s next: Considering a loan with PMI
Private mortgage insurance is a trade-off. Paying PMI can help you get a loan with a smaller down payment, which can be a big help for first-time homebuyers or other people who haven’t been able to save up enough cash to make a 20% down payment on a home.
However, PMI adds to your monthly costs and is coverage for your lender and not you. As you consider whether to take out a loan with PMI, you must balance these two factors and decide whether one outweighs the other.
If you don’t have enough money for a 20% down payment, a loan with PMI is not your only option. Some lenders offer loans with a low down payment that do not require PMI, and some state housing finance agencies may offer loans without mortgage insurance as well. Your interest rate may be higher with these loans, however, which may or may not be more expensive than PMI in the long run.
Your lender should be able to help you run the numbers for several different loan options — with and without PMI — so you can make the best decision.