Private Mortgage Insurance: How PMI Works

If you do one ADVANCES with less than 20% down on your home, you may need to purchase private mortgage insurance, or PMI. When you make a smaller down payment, lenders tend to consider you a higher risk candidate for a mortgageand the PMI requirement protects your lender in case you default on your loan.

Although PMI makes it possible for potential homeowners, especially first-time buyers, to qualify for a mortgage with less than 20% down, the monthly premium will add hundreds of dollars to your mortgage payment each month — so be sure to take this into account when finding your expenses the budget for the purchase of the house. PMI is required for conventional loans and Federal Housing Association loans, but some types of loanslike VA Loanthey don’t ask for it.

Here’s everything you need to know about PMI, how it works, when you need it, and how much it will cost you over the life of your mortgage.

What is PMI and how does it work?

PMI offers buyers the opportunity to purchase a home using a conventional mortgage loan with less than a 20% down payment required. PMI protects lenders who offer lower down payment financing options. If you are unable to make a 20% down payment, lenders consider you a riskier borrower with a greater chance of defaulting on your mortgage. If that were to happen, the lender can use the PMI maintenance payments you paid up until the default to recoup some of their loss.

Cost of PMI

PMI borrowers typically pay between 0.5% and 1.5% of the loan amount on average each year — or between $30 and $70 per month per $100,000 borrowed, according to Freddie Mac. For example, if you take out a $250,000 loan with a 5% down payment, PMI would add between $1,188 and $3,563 a year—or roughly $100 to $300 to your monthly mortgage payment.

How you pay PMI, whether monthly or yearly, varies by lender. Some may also allow you to make a partial down payment at closing, which can lower your monthly or annual PMI payments.

How to lock in a low PMI rate

  • Credit score: The higher it is credit scorethe more chance you have of locking in a lower mortgage interest rate and PMI premium.
  • Prepayment: The closer you get to a 20% down payment, the lower your PMI rate will be and the faster you can get rid of it.
  • Occupation: Owner-occupied properties receive PMI rates lower than rental or investment property.

When can I stop paying PMI?

PMI is usually no longer required once you have at least 20% equity in your home — either from paying down the principal or from increasing the value of your home. In fact, your lender is required to cancel your PMI once your mortgage balance reaches 78% of the original purchase price of your home.

However, some lenders may have further requirements that you must meet before meeting your PMI obligations. These may include making a certain number of mortgage payments, getting a new appraisal, or owing less than 80% of your loan principal.

Although this process can vary slightly by lender, you can usually request PMI cancellation in writing once you reach the 80% loan-to-value threshold. You must meet specific requirements set forth by the Consumer Financial Protection Bureau, including:

  • A record of good payment history
  • Current loan status (not in default)
  • Equity must not be subject to a subordinated loan
  • Evidence of value, if required (achieved through an appraisal)

Borrowers with Fannie Mae or Freddie Mac mortgages have a different PMI waiver threshold if the mortgage is between two and five years old. For these borrowers, equity must be at least 25% before PMI can be completed.

Benefits of PMI

Although PMI adds an extra expense to your monthly mortgage payments, in some cases, it can be worth it. Here are some benefits of PMI:

  • You can buy a house faster: For many would-be homeowners, high down payment requirements make owning a home seem out of reach. With down payment requirements as low as 3%, borrowers can buy a home faster.
  • You are able to build wealth faster: Owning a home can help increase your net worth. Buying a home faster with PMI can also help you build equity faster, which, in turn, can help you eliminate PMI faster.
  • It is only a temporary cost: Once you reach an 80% LTV ratio (75% for Fannie Mae and Freddie Mac loans), you can request PMI waiver. If you don’t request it, lenders are required to automatically waive PMI when you reach 78% LTV.
  • PMI is currently tax deductible: If you file an itemized tax return, you can currently deduct private mortgage insurance from your tax return until the end of 2021. This tax break was revived in the Consolidated Further Appropriations Act, 2020 and extended until 2021 in Consolidated Appropriations Act in January 2021.

Weaknesses of PMI

Although PMI can help you secure a mortgage with a lower payment, there are some disadvantages to consider.

  • It is an additional premium: No matter how low your PMI interest rate is, you’ll still pay an additional expense each month.
  • PMI rates can be high: PMI rates are determined based on your credit score, home occupancy, down payment amount and equity rating. A high PMI rate can increase your monthly mortgage payment by more than you can comfortably afford.
  • Canceling PMI takes time: You are still required to pay PMI until the lender cancels it at 78% LTV. When requesting cancellation sooner, you will often need to make a formal written request, which may take time to process and remove. You may also have to pay for an appraisal if your lender requires one.

Do all home loans require PMI?

Although PMI is usually only required for conventional mortgages, other specialized types of mortgages have their own version — with their own set of requirements.

  • Conventional mortgages: If you put down less than 20% on a conventional loan, expect to pay PMI. There are some non-PMI options, but they usually involve higher interest rates, which can actually cost you more in the long run.
  • FHA Loans: FHA loan allows you to borrow with only 3.5% down and have a monthly insurance premium or MIP. Depending on your lender, your MIP may require a down payment at closing and monthly or annual payments thereafter. Borrowers who put down 10% or more must pay MIP for 11 years, while borrowers who put down less than 10% must pay PMI for the life of the loan.
  • USDA Credits: Although Credit from USDA no down payment required, there is a mortgage insurance requirement, with upfront and annual fees attached. An upfront fee of 1% of the loan value must be paid at closing and annual fees of 0.35% must be paid annually. Although USDA mortgage insurance cannot be canceled, it is usually more affordable than FHA MIP and interest rates tend to be lower.
  • VA Loans: There is no mortgage insurance requirement for VA loans, but borrowers will have to pay a one-time origination fee of between 1.4 and 3.6%, depending on the down payment amount. This fee can usually be rolled into the loan amount.
  • Credit for ARM: An ARM, or adjustable rate mortgage, may also include PMI. The upfront cost may be higher, but you may be able to build equity faster, allowing you to eliminate PMI faster than with a fixed-rate mortgage.

Is PMI worth the expense?

There is a trade-off here. PMI increases your monthly mortgage payment, but it can allow you to buy a home with a lower down payment. That being said, you may be able to waive PMI if you get another type of loan such as a conventional USDA, VA or non-PMI loan — or by saving up for a larger down payment. If you decide to go the PMI route, compare private mortgage insurance rates from a variety of lenders before making a commitment.

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