What Is Private Mortgage Insurance (PMI) – How to Avoid Paying It

house calculatorIf you look at your monthly mortgage statement and see a line for “PMI,” you’re paying for private mortgage insurance. It probably costs you between $50 and $200 per month, depending on the balance of your loan and your PMI rate.

But why are you paying it? Essentially, your lender is requiring you to pay the premiums for an insurance policy that partially reimburses them should you default on your mortgage. We’ll discuss when you’re required to have PMI, what this insurance protects, who needs to carry it, and ways to avoid paying it.

Loan to Value (LTV) Ratio

The loan to value (LTV) ratio is what the lender looks at to determine whether or not you need to pay PMI, and when you can stop paying it. To calculate this ratio, take the amount of the loan and compare it to the current value of your house. For example, if your mortgage is $150,000 and your home is currently worth $200,000, your loan to value ratio is 75%.

When you buy a new home, your lender will look at the amount of your down payment compared to the sales price to determine your loan to value ratio. So if you purchase a home for $200,000 and put $20,000 down, your loan to value ratio is 90%. Typically, if your loan to value ratio is more than 80%, you’ll be required to pay PMI.

What Is Private Mortgage Insurance?

When you apply for a mortgage, the lender wants to make sure your home will have enough equity to pay off the loan balance should you default and go into foreclosure. But since foreclosed upon homes are often sold at a “discount,” lenders want a buffer of at least 20%. In other words, they want to be reasonably sure they can recoup the money they loaned you if the home has to be sold at a lower price than the original sales price.

However, this doesn’t mean that lenders are unwilling to write loans when you put down less than 20%. They just charge you more for the privilege via PMI. In this way, you get a mortgage, and they minimize their risk in offering you a loan. Private mortgage insurance is an actual insurance policy issued by an insurance company that benefits your lender. If your home goes into foreclosure and the lender is not able to recoup the outstanding balance by selling the home, the insurance company that issued your PMI will pay the lender the difference.

PMI is called “private” because it is only offered to private companies and not government agencies or public mortgage lenders. Public programs, such as the FHA and VA mortgage programs, have their own mortgage insurance, but it is run differently and managed internally. However, one notable difference between PMI and mortgage insurance attached to many FHA and VA loans is that the latter never expires. In other words, you will continue paying mortgage insurance on FHA and VA loans even after your loan to value ratio has dropped below 80%.

Who Needs Private Mortgage Insurance?

Generally, if your LTV ratio is less than 80%, you’re in the clear. However, if you have poor credit or are otherwise considered a high risk to the lender, you may be required to carry PMI even if you have a 70%, 60%, or even 50% loan to value ratio.

You may be considered “high-risk” if you’ve sold multiple homes recently, have been foreclosed upon, or if you have an unsteady or undocumented income. However, this should be clearly laid out in your loan documents, and if you aren’t sure how it works, get a clear answer from your loan officer before signing.

house pmi money

How to Avoid Paying Private Mortgage Insurance

The best way to avoid paying PMI is to not have it on the loan to begin with! If you are purchasing a new home, but won’t have a significant down payment, ask your loan officer for suggestions on avoiding PMI.

In the past, a popular option was the 80-10-10 or piggyback mortgage, which used a combination of a second mortgage or home equity loan and your down payment to reduce the loan to value ratio of the primary mortgage. This may still be available through some lenders today.

But if you are already in a mortgage that has PMI, you have two options to remove it:

1. Meet the Loan to Value Ratio

If your loan is near the 80% threshold or whatever threshold your lender stipulated in the initial mortgage paperwork, PMI will be automatically removed by the lender. In practice, most lenders wait until 78%, but if you call and ask, they will remove it sooner.

Since your lender will calculate LTV off the original purchase price, you’ll need to keep track of your home’s current market value. In other words, if your home has increased in value, you can obtain a professional appraisal and present this to the lender as proof that the value has increased.

While professional appraisals usually cost a few hundred dollars, this can be money well spent if it gets you out of paying PMI several months or years earlier than you otherwise would have.

2. Refinance the Mortgage

Before you refinance a mortgage, weigh the expense against the monthly savings. Also make sure you’re comparing apples to apples. In other words, if you have 25 years left on your current loan, request lender quotes for a 25-year mortgage on your current loan balance amount and see how the numbers add up.

If your current loan requires PMI and a new one would not, and if you also qualify for a lower interest rate, a refinance will probably make sense. For example, let’s say your current loan requires a loan to value ratio of 70% before you can stop paying PMI and your current loan to value ratio is 75%.

If your credit has improved since you applied for the original mortgage, you may be able to refinance into a new mortgage where the threshold for PMI is 80%. This means you wouldn’t have to pay PMI with the new mortgage.

But to determine if this refinance actually saves you money, look at how long it takes to recoup your closing costs via your monthly savings, and make sure you’ll be in the house that long. Again, and this can’t be overstated, make sure you’re comparing apples to apples when reviewing lender quotes: the new loan term and balance need to be the same as what’s on your current mortgage.

Final Word

Paying private mortgage insurance is often a necessary cost if you want to purchase a home without a significant down payment. However, you need to understand the terms of your current mortgage contract and calculate your loan to value ratio to avoid paying it longer than absolutely necessary.

Moreover, knowing when and how to remove PMI will lower your monthly mortgage bill. Follow the tips above and the next time you apply for a mortgage, make sure you understand the PMI rules and ask for clarification before signing.

Are you paying private mortgage insurance? What are some of the steps you’re taking to remove it from your mortgage loan?

  • http://www.assurancehabitationguide.com Mr. Assurance habitation

    Thanks for this useful post. Really appreciate it. House insurance is a really a debatable issue under this economic down slide. I have bookmarked your blog. And I would sharing with my friends on facebook. Cheers mate.

  • DaveMortgage

    Contact your current lender 1st. They will order the appraisal from an appraiser on their approved list. Expect to pay $350 +/-

    May 1st new Reg’s for appraisers, banks, lenders and brokers- google
    Home Valuation Code of Conduct – HVCC

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  • http://www.artificialrobot.com Sean

    I know this may sound disingenuous, but why is it so wrong to wait until you have 20% for a down payment before you buy? Buying a home is an awesome thing, but if you don’t have 20% to put down you may want to wait for more reasons than just to avoid paying PMI. With everything that has happened in the past year it seems like it should be a warning to future home buyers. Make sure you are prepared to pay your mortgage and have enough equity in your home to make it worth while for you.

    • http://www.BecomingMortgageFree.com Ron Borg

      With all due respect, the cause of the credit and housing nightmare we’re going through had absolutely nothing to do with low down payment mortgages. FHA had been providing 97% loans since WWII without any problems. FHA was always self-funded… never needed a bailout of tax payer funds at any time. Fannie Mae and Freddie Mac offered 95% loans since the 80’s. But the policies of Greenspan’s Fed lowered interest rates to record levels after 9/11. That caused Wall St to start look for higher yields. They found it in sub prime mortgages. It was then that new loan programs were developed that allowed people to buy homes that had no business doing so. They got into their homes through 2 extremely bad loan programs – the 2/28 and the 3/27. These products practically forced people to refinance after the initial fixed rate period because the rate would jump at that point. Loan officers with no conscience and ignorant borrowers grabbed these loans. And with that came rampant speculation… another primary cause of the credit crisis.

      • Dj947

        Sorry Ron, but there are / were no bad loan products (2/28, 3/27, 5/1, option arms, interest only, etc) There were and still are rotten, corrupt and dishonest loan originators. This includes brokers, banks, and builder’s captive mortgage originators. All of these products work for very specific situations. And all of them have backend rebates based on the loan margin. You know this as a 25 year loan veteran. And you also know that the crooked L.O.s gunning for a fat commission would stick clients with 3-4 point margins ensuring the toxicity of the loan. I stopped counting the number of people that called me from the closing table complaining that their builder promised 1% 30Y fixed now really was an option arm. And when I told them they could walk, they whined that they would loose their earnest moeny deposit or granite countertops.

        And if you think the big banks L.O.s are honest, well, look at the latest ripoff – how the big banks bundled non-allowable fees into VA purchase and refi loans.

        The truth is that many L.O.s are simply crooks.

    • brreyno

      Without it you’d be stuck trying to save up for a house while still paying rent at an apartment. All of that rent money is essentially wasted. So even though you have to pay a premium for not having 20% your still coming out ahead.

      • http://www.homebidz.co Monica

        Good point.

  • http://madsaver.com Mac

    Or…you could also avoid the insurance by getting a line of credit loan to bump the mortgage down to the 80% level. Probably not as easy to do in this market anymore, and then you’ll have to pay the higher interest rate on this loan, but it’s an option.

    • http://madsaver.com Mac

      Hate to piggyback on my own reply, but…just learned that piggybacking your mortgage with a 80/10/10 deal is actually quite popular. 80% of the loan is the regular mortgage, 10% down of your own money, and another 10% separate loan. Avoids the extra fees of a PMI.

  • Jshearerorcl

    Another tip not mentioned in the article – shop for the best price on PMI. You can likely beat the cost of the one the lender puts you in.

  • Dj947

    from a retired Mortgage Banker. PMI is one of the great consumer rip offs. Not only does it not protect the homeowner, the lenders get commissions and kickbacks for writing the policies. Most lenders will make it very difficult to end the PMI when you finally get your LTV under 80%. You don’t even get to read the fine print until AFTER you buy the PMI. There are hidden requirements to pay PMI for 5 to 7 years regardless of the LTV. There are restrictions about ending PMI at 80%, 78% is common, but if there was a single late payment or a dispute, or the banker had a headache they will deny ending the PMI. Best advice – avoid PMI any way you can.

  • http://damianscott.yolasite.com/best-travel-money-rates.php Vernon Groston

    A lot of banks are requiring PMI to avail of their loans whether its a housing loan or a car loan. That’s why its better for me to save money to buy a car rather than having a loan with lots of requirements like PMI.

  • B2erie

    are you listening to what you are saying? Why accept an appraisal onlyh after the ownership as a statement of value when you (the buyer) pay for the appraisal and only the bank benefits from it and then does not use it except to make sure the purchase price is below the appraised value. They are double dipping the buyer for their friends in the PMI business. The appraisal rules in extinguishing PMI but how can it be over ruled by the purhcase agreement of a good negotiator now penalized. I say 1 minutes after buying and getting PMI put on you that you use that same appraisal to extinguish that rediculus instrument in the case where the equity is to be king to show you are 20% down. Apraisal – purchase prices + down payment as equity and divide by loan as true LTV. The bank “accepts” the appraisal” so use their process to boost your equity. However, I have not heard if they go out and appraise to find your value lower and keep sticking you in the eye with your PMI…

  • michelle

    I bought a home 2 years for 115000.00 with very little money down, so I was told that I would need PMI, the house is currently appraised by the city for 96000.00, I had to take a second mortgage out for the down payment. That is at 3,000.00 now. I am hoping to take my tax refund to pay this off , also paying on the principal as well as the payments are only 25.00. So once the second mortgage is pay does the PMI go away? Will this lower my mortgage payment?

  • donna

    Is it true you only have to pay PMI for 4 years?? And will my monthy payment go down?

    • oSnapMillerTime

      No its 11 years or the LIFE of the loan with new FHA loans

  • oSnapMillerTime

    BE WARNED!!!! FHA loans now require you to pay PMI (Or MIP as they call it) for either 11 years or the LIFE of the loan depending on the LTV ratio!!!! People are not being told this!! PMI is very expensive!!