A mortgage is one of the most common types of home loans. It can help you get the funds necessary to purchase a house without paying cash upfront.
When you take out a mortgage, however, you might be responsible for costs besides the loan principal and interest. For instance, if you put down a deposit that is less than 20% of the home’s sale price, your mortgage lender may require you to get a type of insurance called PMI.
If you are getting ready to take out a mortgage, here is everything you need to know about PMI, including who needs it, how it works, and how much it costs.
What Is PMI?
PMI stands for Private Mortgage Insurance. As the name suggests, PMI is a type of insurance policy that some lenders require home buyers to have.
Typically, you are required to purchase PMI if you’re taking out a conventional loan, and the down payment on your house is less than 20% of the home’s value. Many lenders also require PMI if you refinance your home and have less than 20% equity in the property.
The point of PMI is to protect the lender when you borrow money. If you stop making your mortgage payments, the insurance company that supplies your PMI reimburses the lender for the amount you owe. Unlike personal insurance policies, like home or auto insurance, PMI does not offer any protection for you as the borrower.
How Much Is PMI?
PMI is not a fixed cost. Like mortgage rates, PMI prices fluctuate based on real estate market conditions and a variety of other factors.
However, PMI usually costs anywhere between 0.5% to 1% of the amount of money borrowed. So, if you borrowed $200,000 to purchase a home, your PMI would likely cost between $1,000 - $2,000 per year. If you paid monthly, it would cost around $166.
In addition to the PMI rate, the insurance company may also look at other factors to determine your premium. For instance, your credit score can impact the cost of PMI. In addition, your down payment can also affect the cost of your insurance policy. Generally speaking, the higher your down payment is, the lower your PMI premium will be.
PMI Payment Options
There are several ways that you can pay for PMI. The most common option is to pay the premium on a monthly basis, as you would with any other insurance policy.
Your lender might also give you the option to pay for your PMI upfront along with your other mortgage closing costs. The last option is to pay a portion of the PMI upfront, and pay the rest overtime in monthly installments.
How To Avoid PMI
The best way to avoid PMI is to put more than 20% down on your home. Lenders only require PMI if your down payment is less than 20% of the home’s purchase price. When you reach 22% equity in the home, you no longer have to pay PMI.
Another way to avoid PMI is to ask your lender to pay the insurance premium upfront on your behalf. Some lenders are willing to do this, but they generally raise your mortgage interest rate as a result. It may be worth comparing the cost of PMI and the higher interest rate before you choose this option.
The last way to avoid paying PMI is to take out a VA loan, if you meet the qualifications. VA loans are the only type of mortgage that never has insurance requirements. Although PMI is only required with conventional mortgages, FHA loans and USDA loans often have their own unique insurance requirements.
Down Payment Requirements
When you take out a conventional mortgage, PMI is always required if your down payment is less than 20% of the home’s purchase price.
Here’s an example of how it works:
Imagine you want to purchase a house for $350,000 and you put $250,000 down. That would be a down payment of about 70%. In this case, you would not be required to pay PMI because your down payment is more than 20%.
Now imagine you want to purchase a $350,000 house and you put $30,000 down. In this case, the down payment would only be 8.5% of the sale price. Therefore, you would be required to pay PMI until you reach 22% equity in the home.
You might find some mortgage lenders that do not have a down payment requirement for PMI. However, be advised that these lenders typically charge much higher interest rates to offset their potential risk.
How To Cancel PMI Coverage
While PMI can be expensive, the good news is that you don’t have to pay it forever. Once you have 22% equity in your home, your PMI gets canceled automatically by your lender’s insurance company, and you no longer have to pay the premiums. However, you are allowed to cancel your PMI before you reach the 22% equity mark if you meet certain qualifications.
Once you have 20% equity in your home, you can request to cancel your PMI. You can also request to cancel your PMI if you make significant home improvements or renovations that would increase the value of the property. Similarly, you might be able to cancel your insurance policy if your home’s value increases naturally based on the current real estate market conditions in the area.
Frequently Asked Questions
Why do I have to pay for PMI?
If your mortgage provider requires you to get PMI, it’s a condition of your home loan. It protects the lender in the event that you default on your loan (when you stop making the payments). With PMI, the lender gets the full amount of money back from the insurance company, so they don’t lose any money when you don’t pay back the full balance.
What's the difference between PMI and mortgage protection insurance?
Mortgage protection insurance is a type of insurance that protects you as the borrower. If you lose your job, become disabled, or pass away before your mortgage is paid off, this policy will cover the remaining balance. Unlike PMI, mortgage protection insurance is optional. The main difference between the two is that mortgage protection insurance covers the borrower, whereas PMI covers the lender.
Should I pay off my PMI early?
Paying off your PMI early is a smart decision for most people. It will eliminate your monthly payments, which means you will put less money toward your loan overall. However, keep in mind that you don’t have to pay PMI forever. Once you reach 22% equity in the home, your PMI will be automatically canceled and the payments will stop.
Is PMI insurance still required?
Yes, PMI is still a requirement for most conventional home loans if you put less than 20% down on the property. Some lenders don’t require borrowers to get PMI, but as a result, you typically pay a much higher interest rate. Therefore, you may not actually save money by avoiding PMI.