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

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There are a lot of terms that come up when you’re buying a house. You might be familiar with some and less so with others. If you own a home or are considering buying one, you may have heard about private mortgage insurance (PMI). This type of insurance may be required as part of your loan agreement, so it’s good to know what it is and how it might affect your monthly mortgage payment.

Let’s discuss what PMI is, when you need it, how to avoid paying PMI, and how to get rid of it so you have all the details before you take out a loan.

What Is PMI?

Private mortgage insurance, or PMI as it’s more commonly referred to,  is something lenders require homeowners to get when they purchase a house and put down less than 20% of its value. You’ll typically find PMI attached to your mortgage payment if you’re getting a conventional loan. Other loans, such as an FHA loan and USDA loan, have their own type of mortgage insurance. These loans are backed by the government, so they work a little differently.

Nearly all investment properties will require you to put down 20%, so you won’t likely encounter PMI when buying an income-producing property. And they require you to put that much down because you’ve just made a huge investment, which they’ve financed, and they need to know that if you default on it, they can recoup their costs.

How Much Is PMI?

How much you pay for PMI will depend on a variety of factors. Because PMI is an insurance product, the price fluctuates depending on insurance rates. However, the typical cost of PMI is anywhere from 0.5% to 5% of the loan amount. Your PMI is rolled into your mortgage and calculated as a monthly fee that’s part of your monthly mortgage payment. Here’s more about how insurers calculate your PMI costs and an example to further illustrate how much you could pay for PMI:

What factors impact PMI costs?

Your loan company will use these factors to calculate what your PMI will cost:

• Loan amount.
• Credit score.
• Debt-to-income ratio.
• Home’s value if an insurance claim were to pay out.

The loan amount is a major determinant for PMI, but your credit score could make a big difference in your PMI payment as well. This is because those with a higher credit score are less of a risk to lenders. To keep your credit score high, make your debt payments on time and keep your debt-to-income ratio low.

Another factor that affects your PMI is how much an insurance company might pay out if you make an insurance claim on the house. This isn’t the same as the home’s market value because insurance companies have their own method of calculating a home’s actual cash value. These factors give lenders an idea of how risky you are to loan to, and they use this to determine your PMI rate.

PMI cost example

Let’s look at an example of PMI based on these amounts:

• Home cost: $300,000.
• Down payment: $30,000.
• Loan amount: $270,000.
• Credit score: 680.
• Interest rate: 6%.
• Term: 30 years.

Using these numbers and an estimated PMI rate of 1.21%, the PMI for this loan will cost $272 per month. This means that the total PMI will amount to $24,190 by the time the borrower reaches the 20% equity mark.

Using the same numbers from above but adjusting the credit score to 750 could reduce the PMI to $158 per month or $13,994 until the 20% equity mark is met. A higher credit score means a lower PMI rate and saving on mortgage payments each month.

The $30,000 down payment is only 10% of the cost of the home, so if we raise the down payment to closer to the 20% mark, say $45,000, and use the same numbers from above, the PMI will cost $257 per month, but borrowers only pay $13,338 by the time they reach 20% equity in the home.

So you can see how various factors can affect the PMI. Your exact mortgage insurance will depend on your personal finances and the home you want to buy.

How Do You Get Rid of PMI?

Lenders will allow you to remove PMI once you’ve paid the equivalent of 20% of your loan, but most won’t automatically remove it from your payment until you have around 22% equity. Knowing this, it does make a lot of sense to put as much money down upfront as you can for a lot of reasons, one of which is that you can avoid paying PMI costs or lessen the amount you will owe over time. Because the PMI requires 20%, on average it takes about 10 years to get rid of this extra cost on a mortgage that starts with only 5% down.

How to Avoid PMI

That said, there are some workarounds for this. These are some options you might take advantage of if you want to avoid PMI.

Refinance your home

We help real estate clients in Colorado and have seen huge gains in both markets over the past couple of years. This can be advantageous to a recent homebuyer who lives in a neighborhood with large appreciation gains. Specifically, if your home has appreciated significantly in the past year or so, you may be able to drop your PMI. This is possible because if your home appraises high enough and you gain a significant amount of equity, you may own more than 20% of your home’s value.

How’s that? Well, if the house appreciates $100k in a year and that $100k is worth more than 20% of the house value, you now own more than 20% of the house. And that qualifies you to drop your PMI.

One important point to note: Refinancing your home requires getting a new loan, and consequently, you’ll be paying closing costs all over again. This can be expensive, so it’s important to see if it’s worth it over the long term.

Wait two years

This applies to hot markets again, but if you can wait two years, you can avoid closing costs. If your home has appreciated 25% or more in that two-year time frame, then you only need to pay for the cost of an appraisal — usually $400-$500. As long as your primary residence has appraised 25% or more after two years and you haven’t had any late payments in the past 12 months, you are eligible to drop your PMI. If your home is five years or older, you only need it to appraise at 20% or more.

This is a great way to save yourself some money and drop what can be a long, and lengthy payment.

Get a VA loan

If you’re a veteran, you could qualify for a VA loan. These loans don’t have mortgage insurance. Instead, there’s a one-time funding fee that’s paid at closing, or sometimes, it’s tied into the loan amount. If you roll the funding fee into your VA loan, you pay interest on it, making it beneficial to pay it all at closing if possible.

The larger your down payment, the lower the funding fee. This can save you money at closing or when making monthly payments. The typical funding fee ranges from 1.25% to 3.3% of the total loan amount. It depends on the type of loan you’re applying for and your military category. Whether you have entitlement and how much can also affect the funding fee.

Use a piggyback loan

With a piggyback loan, you’re using two loans, a primary mortgage and a smaller, second mortgage, to make a home more affordable and possibly avoid PMI. The primary mortgage pays 80% of the loan, while the second loan pays 10%. You’ll need to come up with a down payment of 10%, which will provide you with a 20% down payment. Combining your 10% savings with the second loan’s 10% contributions puts you at 20%. Now you can qualify for better fixed rate mortgages or adjustable rate mortgages when you buy a home.

You might not have a lower payment with a piggyback loan method since you’ll be paying two loans with two interest rates. Make sure you look at the numbers before you decide if this is the best option.

Borrower-Paid PMI vs. Lender-Paid PMI

There are several types of insurance homeowners need, but unlike homeowners insurance which protects your home and belongings, private mortgage insurance protects lenders from losing too much if you default on your loan. The two main types of mortgage insurance are borrower-paid PMI and lender-paid PMI.

Borrower-paid PMI is the type we’ve been talking about. It’s paid by the borrower and is tied to the monthly premium until the borrower has 20% equity in the home. In some cases, a borrower might have the option to pay the PMI as a single premium, taking care of the entire amount upfront. Some lenders may also allow borrowers to pay a portion of the PMI upfront and the rest as lower monthly premiums.

Lender-paid PMI, on the other hand, is arranged and paid by the lender. Because lenders can access better insurance rates by pooling a lot of people for bulk pricing on premiums, you could save on your monthly mortgage with lender-paid PMI. Of course, the lender usually passes this service on in the form of a fee. This fee means you pay a higher interest rate. You’ll also have to pay the loan off in full or refinance to get rid of lender-paid PMI, so you could end up paying more over the life of the mortgage.

FAQs

Use these answers to frequently asked questions for more guidance on PMI and what it means for your mortgage:

How long do I have to pay PMI?

The PMI is rolled into your loan until you own 20% of a home’s value. How long you have to pay PMI will depend on your down payment. The closer you are to having 20% down, the less time you have to pay PMI on your mortgage. PMI protects the lender, so you have to pay it until they see your loan as less risky. To avoid paying PMI, you have to put at least 20% down on a conventional loan.

Is it better to put 20% down or pay PMI

Depending on your credit score, the price of the home, and how much you have saved for a down payment, it can be better to pay PMI than wait until you have 20% down. If you can start building equity in a home sooner by putting down less than 20% now, it can be worth it to pay the PMI. Having a high credit score can help lower your PMI premium each month.

Do PMI costs decrease over time?

Every year when your loan balance is recalculated, your PMI is recalculated as well. This means that as you pay down the loan, the monthly PMI costs decrease.

What happens if I default on my mortgage and have PMI?

Mortgage insurance protects the lender if you default on your loan. The mortgage insurance company reimburses the loan company some of their losses to account for your nonpayment. The PMI company could try to obtain reimbursement from you at a later date to cover their loss from paying the loan provider after your default.

Is PMI tax deductible?

Unfortunately not. PMI is no longer tax deductible starting with the taxes you file for 2022. Although, you may be able to use the PMI as an itemized deduction if you’re within a certain income level.

Does PMI apply to all types of mortgage loans?

PMI only applies to conventional loans where a buyer puts down less than 20%. Other types of loans have their own types of mortgage insurance that help protect the lender if the borrower defaults on their monthly payments.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.