What is private mortgage insurance (PMI)?
If you see a line for “PMI” on your monthly mortgage statement, you’re paying for private mortgage insurance.
But what is it actually for? Who has to pay for it, and who doesn’t? Most importantly, how can you avoid it moving forward?
To save yourself between $50 and $250 each month, here’s everything you need to know about PMI.
What Is Private Mortgage Insurance?
Lending money comes with risk: some borrowers inevitably default and stop sending money to repay their debt.
So lenders look for ways to protect against that risk. In some industries, like payday loans, lenders simply charge so much interest that they still earn a profit on the borrowers who do pay their loans back in full, despite high default rates.
The home mortgage industry is regulated more tightly. Lenders charge much lower interest, and they protect themselves from losses in two ways. First, they place a lien against the property — if the borrower defaults, they can foreclose to sell the property and recover their loan.
But the foreclosure process is long and expensive for lenders, and foreclosed homes sell for less than normally listed homes. That leaves lenders with a loss if there isn’t much equity in the property.
Which raises the second protection mechanism for mortgage lenders: mortgage insurance. Paid by the borrower, mortgage insurance protects the lender against the risk of loss due to the borrower defaulting.
Private mortgage insurance is an actual insurance policy issued by a licensed insurance company. If you default on your mortgage payments and your lender loses money after foreclosing and selling your home, they file a claim on your mortgage insurance policy. The insurance company then writes them a check for some or all of their loss.
The Role of Your Down Payment
Not everyone has to pay for mortgage insurance when they take out a loan.
If you make a down payment of 20% or more when buying a home, you don’t need to pay for PMI. That’s assuming you take a conventional mortgage rather than an FHA or VA loan — more on that shortly.
When you take out a mortgage loan, the lender offers you a loan up to a certain percentage of the property’s value. In the case of a home purchase, the value is the purchase price. When you refinance an existing home, the value is based on the lender’s appraisal.
The percentage that you end up borrowing is called the loan-to-value ratio, or LTV in the lending industry. For example, if you borrow $150,000 when buying a home for $200,000, that makes your LTV 75%.
Only borrowers who take out more than 80% LTV have to pay for mortgage insurance.
Mortgage Insurance for Conventional vs. FHA, USDA, and VA Loans
The term “private mortgage insurance” only applies to conventional mortgages. These typically mean loans that conform to Fannie Mae or Freddie Mac loan programs.
Conventional loan programs allow borrowers to apply to remove PMI once they pay their loan balance down below 80% of the property value. That can help buyers get in the door with a low down payment, then remove the monthly PMI fee after a few years of paying down their mortgage balance.
Several government agencies offer their own unique loan programs, specifically designed to help first-time borrowers buy with little money down. The most common of these is the Federal Housing Administration’s loan program, which allows buyers to put down as little as 3.5%.
As tempting as that sounds, it comes with a catch. You have to continue paying the mortgage insurance premium (MIP) for the entire life of the loan if you put down 10% or less, no matter your remaining loan balance. Buyers must also pay an upfront MIP fee at closing (more on that shortly).
If you qualify for a USDA loan for a rural property, the MIP works similarly. You pay an upfront fee, then ongoing monthly MIP payments for the entire life of the loan.
Military veterans have access to VA loans as another option, which offer some enticing perks. These loans allow as little as 0% down, which almost no other loan programs do.
They also handle mortgage insurance differently, with no monthly insurance premium. Instead, they charge an upfront fee called a VA funding fee, which you can roll into the loan in many cases. It serves a similar function of protecting the VA against losses from defaults.
Note that the VA offers some exceptions to the VA funding fee requirement, such as for disabled veterans and surviving spouses.
How Much Does PMI Cost?
For conventional mortgage loans, expect to pay between $40 and $70 per month for each $100,000 of loan amount. The PMI premium varies based on your LTV and other risk factors — play around with Freddie Mac’s PMI calculator to get a better idea of the cost of PMI.
For FHA loans, mortgage insurance rates are priced differently. Borrowers must pay 1.75% of the loan amount at closing for the upfront mortgage insurance premium. As for the monthly premium, it varies based on the length of the loan and your LTV — see FHA’s MIP charts for more details.
As for USDA loans, MIP costs less. These loans charge 1% of the loan amount for upfront MIP, and 0.35% of the loan amount annually for ongoing MIP, split into monthly installments.
Borrowers of VA loans pay different amounts for the VA funding fee depending on their LTV and whether they’ve borrowed a VA loan before. View the VA funding fee charts and the full list of exceptions for who has to pay it for more information.
How to Avoid Paying Private Mortgage Insurance
As outlined above, not everyone has to pay for mortgage insurance.
Try these tactics to avoid PMI on your mortgage.
1. Avoid FHA Loans
The FHA home loan was specifically designed for first-time home buyers with little cash and weak credit. Borrowers with credit scores as low as 580 qualify for as little as 3.5% down, which defies “conventional” wisdom.
The FHA makes it work through a combination of taxpayers subsidizing these loans and charging MIP for the entire life of the mortgage loan.
If you don’t want to pay MIP for the entire life of your loan, take out a conforming mortgage instead. That might mean taking some time to improve your credit, perhaps paying off debt or saving a higher down payment as well.
2. Put Down 20%
It’s hardly a plot twist: if lenders require PMI when you put down less than 20% of the home’s purchase price, put down the 20% minimum and avoid it.
3. Consider a Piggyback Mortgage
Although not as common as it once was, some lenders still offer an 80/10/10 piggyback mortgage program.
It involves borrowing two mortgages: a first mortgage for 80% of the purchase price, a second mortgage (or a HELOC) for another 10%, and a 10% down payment. You avoid PMI with the 80% mortgage.
If you can manage a 10% down payment but not 20%, or you worry about crossing over into jumbo mortgage loan territory, ask around among a few lenders about piggyback loans.
4. Pay Down Your Loan Balance Quickly
Some borrowers put down less than 20% and accept the PMI charges, then pay down their mortgage loan as quickly as possible to get it under 80% LTV.
Once your loan balance reaches 78% of the original purchase price or appraised value, the lender must remove PMI automatically based on the federal Homeowners Protection Act, as long as you’re current on your loan and have made your payments on time.
But you don’t have to wait around for the automatic cancellation. If you believe you’ve paid your balance down below 80% of the current value of your home, you can apply to have PMI removed from your monthly payment.
The lender typically sends out an appraiser to assess your home’s market value, so don’t count on them taking your word or a few comps pulled from Zillow. Your lender chooses the appraiser, and you pay their fee, so you can’t just call in a favor from an appraiser buddy of yours.
5. Refinance the Mortgage
Before you refinance a mortgage, weigh the expense against the monthly savings. It rarely makes sense for the homeowner, and all too often serves the lender at their expense.
Refinancing costs you money in many ways. The first, and most obvious, is in thousands of dollars of new closing costs. Lenders try to sweep this under the rug by assuring you “Don’t worry about it, we’ll just roll them into your loan.”
Refinancing also extends your debt horizon further into the future. Lenders simply count on human nature, in discounting the longer remaining loan term as the distant future.
Finally, it restarts your amortization schedule from scratch. That means you go back to most of each monthly payment going toward interest, rather than paying down your principal balance.
Lenders love to pitch you on a refinance by focusing on the monthly mortgage payment. Instead, calculate the total remaining life-of-loan costs for your current mortgage, and compare that to the total life-of-loan cost of a refinance. You probably won’t like what you see.
If your current loan requires PMI and a new one would not, and if you also qualify for a (much) lower interest rate, a refinance might make sense. But run your own numbers carefully before falling for a sales pitch.
Private mortgage insurance is a necessary cost if you want to buy a home with little money down. Which is precisely why you should consider putting down 20% when buying a home.
Understand the differences in mortgage insurance between conventional and government-subsidized loans. Know your options, and make sure you understand the PMI rules before signing on the dotted line.