Private mortgage insurance (PMI) is insurance for your mortgage holder or lender, not for you, the homebuyer. PMI protects your lender in case you are unable to make payments on your mortgage and default on your loan.
Now that you know what PMI is, read more to learn about how it works, how much it costs and when PMI goes away:
How does PMI work?
PMI is required if you have a conventional loan and are unable to put down at least 20% of the home’s purchase price. For example, if you’re buying a home that costs $350,000 and you put down less than $70,000, you may have to make PMI payments.
There are different kinds of PMI. Like other insurance products, there are multiple ways to pay. Here are the types of PMI available for conventional loans:
Borrower-paid is the most common type of PMI. It works similar to other insurance policies you may have. As the borrower, you’ll see PMI charges, sometimes called premiums, on your monthly mortgage statement. The monthly payments for PMI may eventually be cancelled when you have enough equity in your home.
With lender-paid, the lenders pays for your mortgage insurance. It likely comes at the cost of a higher interest rate. Because the insurance is paid for in the form of a higher interest rate, the insurance can’t be cancelled as it is a part of your mortgage.
With single-payment PMI, instead of making monthly payments, you pay the insurance premium in one lump sum at the closing of your mortgage. You can pay in cash or have it financed and included into your home loan. Like lender-paid PMI, the insurance can’t be cancelled and is non-refundable — it’s priced into your mortgage permanently.
Split-premium PMI works as a combination of sorts. Part of the insurance premium is paid up front, while the rest is rolled into monthly payments. The upfront portion can’t be cancelled, but the monthly premiums can be when you have enough equity in the home.
This is a quick glance at the different types of PMI. Each one comes with benefits and drawbacks. There are also different ways to pay for or finance each type. Ask your lender, mortgage officer or lawyer about which type works best for your home purchase and financial situation.
How much does mortgage insurance cost?
The cost of PMI can vary, but according to the latest available data from the Urban Institute, PMI costs on average between 0.19% - 1.86% of the total home cost. Generally, the more you put down when purchasing the home, the less your monthly PMI payment will be. Your credit score and credit history can play a part in your PMI payments as well. A long history of on-time payments will show you’re a responsible borrower, which can help lower your PMI payments.
When does PMI go away?
You don’t have to make PMI payments for the entire length of your loan. If you’re making monthly PMI payments, there are multiple options to have these premiums cancelled. One is to simply wait. When the equity in your home reaches 22%, your lender will automatically cancel your PMI.
Your lender should provide you with an amortization schedule with your original loan documents. This schedule shows each of your monthly payments and how much goes to your principal balance, how much is charged in interest and the remaining principal balance.
Alternatively, you have a right to request your lender cancel PMI when your principal balance is at 80% of the home’s value. Making additional payments towards the principal balance can help you build equity faster than was originally scheduled.
The equity in your home may have improved if your home rises in value after closing. This request must come in writing and your lender may request you get a home appraisal. The Consumer Financial Protection Bureau (CFPB) has more information on PMI cancellation requirements.
The CFPB also states that regardless of your home’s value, your lender must stop PMI at the halfway point of your loan’s schedule. For a 30-year loan, this would mean after 15 years of payments have passed. This type of PMI cancellation is more likely for homeowners making interest-only payments or who are in a forbearance plan.
Benefits of mortgage insurance
Paying extra money each month isn’t necessarily a benefit. But if you are unable to come up with a 20% down payment, PMI is a way for you to secure the home you’re after. Without PMI, if you’re taking out a conventional mortgage, you may need to wait until you can save enough for that 20% down payment.
20% can be a lot of cash to put down. It may dwindle your savings dramatically, ultimately making it tough to cover potential repairs or other expenses your new home may require. You need to make sure you balance the right amount for your down payment and, depending on the condition of your new home, have enough money reserved for home maintenance. Again, work with your mortgage officer and real estate agent to discuss concerns about the best way to financially plan for and finance your home.
Government home loan assistance
Government loan programs are worth exploring if you’re eligible. Government loan programs typically don’t require PMI, but may have additional fees, either added to the mortgage upfront or paid monthly, similar to PMI.
The Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA), all have home-buying assistance programs. Contact the relevant government agency if you have any questions about loan requirements and eligibility.
Do FHA loans require mortgage insurance?
Federal Housing Administration (FHA) loans are mortgages that are insured by the FHA. With FHA-insured loans, you can make a down payment as low as 3.5%. FHA loans do require insurance that is similar to PMI.
FHA insurance includes both an upfront premium and monthly payments. The amount you have to pay can vary based on several factors, including how much money you put down and your credit score. Unlike typical PMI, FHA insurance doesn’t cancel when you reach a certain amount of equity in your home. Instead, for FHA loans, if you made a down payment of 10% or more, you’ll make insurance payments for 11 years. If you made a down payment of less than 10%, you’ll make insurance payments for the life of the loan. You can talk to a housing counselor provided by the U.S. Department of Housing and Urban Development if you have questions about FHA loans.
Do USDA loans require mortgage insurance?
For eligible home buyers in some rural locations, home loan assistance may be available through the USDA loan program. These are attractive loans for home buyers in rural areas because they don’t require a down payment. Mortgage assistance is provided through the USDA, but you’ll apply for a loan with a private lender. Technically, there is no PMI for USDA loans, but you will be charged an annual guarantee fee which is added to the monthly mortgage payment.
Do VA loans require mortgage insurance?
The VA provides a guarantee to a portion of a home loan for eligible buyers. This is a guarantee that the VA will reimburse the lender if you’re unable to make your payments and face foreclosure of your home. There is no PMI with VA loans, but there is an upfront fee that may be added to the overall cost of the home purchase.
There are multiple VA home programs for eligible service members. VA loans don’t require a down payment, unless one is required by your lender. You can read more about VA loan requirements and eligibility in the VA Home Loan Guaranty Buyer’s Guide.
Buying your first home
For most people, buying a home is the biggest purchase — and one of the most important financial decisions — they’ll make. Unfortunately, some aspects of the home-buying journey are outside of our control. The housing market can change, sometimes suddenly. And for many people, having enough cash on hand to put down 20% is an understandable challenge. If interest rates rise or home prices jump and you’re unable to put down 20%, your home purchase may require PMI payments.
But no matter the market conditions, there are still best practices you can follow to prepare your credit to buy a home. The earlier you start preparing your finances, the more confident you’ll feel going into the home-buying process.