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Private Mortgage Insurance: How PMI Works
If you make a down payment of less than 20% on your home, you'll probably have to purchase private mortgage insurance, or PMI. When you make a smaller down payment, lenders tend to consider you a higher-risk candidate for a mortgage, and the PMI requirement protects your lender 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% down, the monthly premium will add hundreds of dollars to your mortgage payment every month -- so make sure to account for this expense when figuring out your home-buying budget. PMI is required for conventional loans and Federal Housing Association loans, but some loan types, like VA loans, do not require it.
Here is everything you need to know about PMI, how it works, when you need it and how much it will cost you over the lifetime of your mortgage.
What is PMI and how does it work?
PMI offers buyers the opportunity to purchase a home using a conventional mortgage loan with less than the required 20% down payment. PMI protects lenders who offer lower down payment financing options. If you're unable to make a 20% down payment, lenders consider you a riskier borrower with a greater chance of defaulting on your mortgage. If that were to happen, the lender could use the escrowed PMI payments you paid up until default to recoup some of their loss.
The cost of PMI
Borrowers with PMI pay typically between 0.5% and 1.5% of the loan amount on average each year -- or between $30 and $70 monthly per $100,000 borrowed, according to Freddie Mac. For example, if you take out a $250,000 loan with a 5% down payment, PMI would add between $1,188 and $3,563 annually -- or roughly $100 to $300 tacked on to your monthly mortgage payment.
How you pay PMI, whether monthly or yearly, varies by the lender. Some may also allow you to make a partial upfront payment at closing, which can lower your monthly or annual PMI payments.
How to lock in a low PMI Rate
- Credit score: The higher your credit score, the better chance you have at locking in a lower mortgage interest rate and PMI premium.
- Down payment: 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.
- Occupancy: Owner-occupied properties get lower PMI rates than rental or investment properties.
When can I stop paying PMI?
PMI is typically no longer required once you have at least 20% equity in your home -- whether from paying down the principal or an increase in your home's value. In fact, your lender is required to cancel your PMI once your mortgage balance hits 78% of your home's original purchase price.
However, some lenders may have further requirements you must meet before satisfying your PMI obligations. These might include making a set number of mortgage payments, getting a new appraisal or owing less than 80% of your loan principal.
Though this process may differ slightly by lender, you can usually request PMI cancellation in writing once you have reached the 80% loan-to-value threshold. You must meet specific requirements as laid out by the Consumer Financial Protection Bureau, including:
- A record of good payment history
- Current loan status (not in default)
- The equity must not be subject to a subordinate loan
- Proof of value, if requested (achieved through an appraisal)
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 borrowers, 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, in some cases, it may be worthwhile. Here are a few benefits of PMI:
- You can buy a home sooner: For many potential homeowners, high down payment requirements make owning a home seem unachievable. With down payment requirements as low as 3%, borrowers can buy a home sooner.
- You're able to build wealth sooner: Owning a home can help increase your net worth. Purchasing a home sooner with the help of PMI may also help you build equity faster, which could, in turn, help you eliminate PMI sooner.
- It's only a temporary cost: Once you've 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 required to automatically remove PMI when you reach 78% LTV.
- PMI is currently tax-deductible: If you file an itemized tax return, you can currently deduct private mortgage insurance from your tax return through the end of 2021. This tax break was revived in the Further Consolidated Appropriations Act, 2020 and extended through 2021 in the Consolidated Appropriations Act in January 2021.
Downsides of PMI
Although PMI can help you secure a mortgage with a lower down payment, there are some disadvantages to consider.
- It's an extra premium: No matter how low your PMI interest rate, you'll still be paying an extra expense each month.
- PMI rates may be high: PMI rates are set based on your credit score, home occupancy, down payment amount, and equity appreciation. A high PMI rate might raise your monthly mortgage payment by more than you can comfortably afford.
- Canceling PMI takes time: You are still required to pay PMI until the lender cancels it at 78% LTV. When requesting cancellation sooner, you'll often need to make a formal request in writing, which can take time to process and remove. You also may have to pay for an appraisal if your lender requires one.
Do all home loans require PMI?
Though PMI is typically required only for conventional mortgages, other specialized mortgage types have their own version of it -- with their own sets of requirements.
- Conventional mortgages: If you put down less than 20% on a conventional loan, expect to pay PMI. There are some non-PMI options, but those typically include higher interest rates, which could actually cost you more in the long run.
- FHA loans: FHA loans allow you to borrow with as little as 3.5% down and have a monthly insurance premium or MIP. Depending on your lender, your MIP may require upfront payment at closing and monthly or annual payments thereafter. Borrowers who make a down payment of 10% or more must pay MIP for 11 years, while borrowers who put down less than 10% must pay PMI for the life of the loan.
- USDA loans: Although USDA loans do not require a down payment, there is a mortgage insurance requirement, with upfront 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. Though 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 origination fee between 1.4 and 3.6%, depending on the down payment amount. This fee can typically be rolled into the loan amount.
- ARM loans: An ARM, or adjustable-rate mortgage, may also include PMI. The initial cost may be higher, but you may be able to build equity faster, allowing you to remove PMI faster than with a fixed-rate mortgage.
Is PMI worth the expense?
There's a trade-off here. PMI increases your monthly mortgage payment but can allow you to buy a house with a lower down payment. That noted, you may be able to forgo PMI if you get a different type of loan such as a USDA, VA or non-PMI conventional loan -- or saving up for a larger down payment. If you decide to go the PMI route, compare private mortgage insurance rates from a variety of lenders before making a commitment.
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