What Is Private Mortgage Insurance (PMI) And Do You Have To Pay It?

Many mortgage programs, including conventional loans, allow you to buy a home with a relatively small amount as a down payment. However, depending on the type of loan you have, you may also be required to pay private mortgage insurance (PMI), which helps mitigate some of the added risk for the lender.

PMI can cost you thousands of dollars per year, but you can avoid it, and even if you do have to pay it, it’s usually only temporary. Keep reading to learn more about private mortgage insurance, when it’s required, how much it costs and how you can avoid it altogether.

What Is Private Mortgage Insurance (PMI)?

PMI, also called private mortgage insurance, is a form of financial protection most lenders require borrowers to pay if they make a down payment of less than 20% on a conventional loan.

Just like other forms of insurance, PMI is there as an added protection. When you buy a home with less than 20% down, there’s more risk on the lender. PMI provides added protection for the lender until you reach 20% equity in your home.

And remember that while PMI seems like a major disadvantage, it also has its perks. For example, if not for PMI, people may not be able to buy a home with less than 20% down. The ability to have a smaller down payment and pay PMI each month helps make homeownership more accessible to those who can’t afford the higher upfront cost.

PMI Vs. Mortgage Insurance Premium (MIP)

When we talk about PMI, we’re generally talking about the mortgage insurance that’s required on conventional loans. FHA loans also require mortgage insurance, but it works a bit differently.

The mortgage insurance on FHA loans, known as mortgage insurance premium (MIP), comes in two forms. First, borrowers must pay an upfront mortgage insurance premium, as well as an annual one. Depending on your down payment and the size of your loan, MIP on an FHA loan may be permanent, unlike the PMI on a conventional loan.

When Is PMI Required?

If you make a down payment of less than 20% of the purchase price with a conventional loan or if you have less than 20% equity in your home, you’ll have to pay PMI.

You may also have to pay PMI when you refinance a loan, depending on your loan-to-value ratio (LTV). LTV refers to the percentage of the home that’s financed. When the home has an LTV of more than 80%, it means the owner or buyer has less than 20% equity and PMI is required.

If you’re required to pay PMI, don’t worry – it won’t last forever. As we’ll talk about in a later section, all conventional mortgages allow you to cancel PMI once you reach a certain milestone.

How Much Does PMI Cost?

The annual cost of PMI will be different for every homeowner based on their lender and unique financial situation. In general, though, PMI tends to cost around 0.2% – 2% of your loan amount each year. So, if you owe $300,000, you can expect to pay between $600 – $6,000 per year.

Remember that you can reduce the amount of PMI you’ll pay by increasing the size of your down payment. Consider an example where you purchase a home valued at $400,000. You’re deciding between a down payment of either 3.5%, 10% or 20%.

The table below shows your total down payment, loan amount and estimated monthly payment based on a PMI of 0.5% and an interest rate of 6%.

How Can You Avoid Paying For Private Mortgage Insurance?

If you’re stressed out by the idea of paying PMI in addition to your normal mortgage payment, rest assured it’s not required on all loans. There are a few things you can do to avoid PMI altogether.

Make A Larger Down Payment

The simplest way to avoid PMI on a conventional loan is by saving up for a down payment of at least 20%. On a conventional loan, you won’t have to pay PMI as long as your LTV is no higher than 80% (meaning you have at least 20% equity in the home).

Not only will a larger down payment help you avoid PMI, but it will also help lower your principal and interest payment, leaving more wiggle room in your budget and ensuring that you’ll pay less in interest over your loan term.

Opt For Lender-Paid Mortgage Insurance

You can also avoid PMI by opting for lender-paid mortgage insurance. Some lenders offer this option in exchange for a slightly higher interest rate on the loan. While this option might seem beneficial, proceed with caution. You’ll still end up paying more each month because of the higher interest rate. And unlike PMI, which can be canceled once you reach 20% equity, the higher interest rate will be there to stay.

Use A Different Type Of Home Loan

Some government-backed loans, including VA and USDA loans, don’t require down payments at all and don’t charge PMI when you don’t have a down payment. These loans can help you save a lot of money because of that benefit.

However, not everyone will qualify for one of these loans. VA loans are only available to eligible military service members and veterans. USDA loans are only available to low- and moderate-income individuals in rural areas.

When Can You Cancel Your Private Mortgage Insurance?

As we’ve mentioned, PMI may be an inconvenience and added cost for a few years, but it doesn’t last forever.

First, lenders are required to terminate PMI when a borrower is scheduled to reach 22% equity (or an LTV of 78%) of the home value based on their original amortization schedule. You won’t have to do anything on your end to make this happen – it terminates automatically.

You may also request that your lender terminate your PMI once you reach 20% equity in your home. You’ll probably have to pay for an appraisal to prove that you’ve achieved 20% PMI. However, it may be worth it if home values have increased and you’re able to get rid of your PMI significantly earlier than originally planned.

Finally, you may be able to eliminate PMI by refinancing your conventional loan with a VA or USDA loan. However, you may be required to pay closing costs and other expenses, which could eat into some of your PMI savings.

The Bottom Line

If you buy a home with a down payment of less than 20%, you’ll probably end up paying PMI. You’ll be able to eliminate your PMI once you reach a certain amount of ownership in your home. Or you can avoid PMI altogether by putting down at least 20%.

If you’re considering buying a home, apply for initial mortgage approval to see how much you qualify for. This will give you a good idea of how much you’ll need to save for your down payment. This can help you decide whether it’s worth saving the 20% required to avoid PMI.