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You have done your research, you’ve studied the mortgage interest rates for the last few months, and now, you’re ready to send in an offer on your dream home.
As you progress on your home buying journey, you’ll probably be faced with a new term: Private Mortgage Insurance or PMI.
So, if you’re like most first-time homebuyers, you may be asking, what is private mortgage insurance?
Keep reading to learn more about private mortgage insurance, how it works, and how you can avoid it.
What is Private Mortgage Insurance?
Private mortgage insurance or PMI is a type of insurance required by conventional mortgage lenders if a borrower’s down payment is less than 20 percent of the home purchase price.
While first-time borrowers always have confusion regarding private mortgage insurance and homeowners’ insurance, these two terms mean entirely different things.
Homeowners Insurance protects you and your home in the event of any damage.
Private mortgage insurance protects the lender if a borrower defaults in the repayment of their loan.
If you put less than 20% for conventional mortgages, you are more likely to pay for private mortgage insurance.
For instance, if you want to purchase a home that costs $400,000, you will need to make a down payment of at least $80,000 to avoid paying for PMI.
More importantly, PMIs are typically associated with conventional mortgages. However, other loan types like FHA and USDA Loans have their forms of PMI.
Only Veteran Affairs (VA loans) do not require the payment of PMIs, but you may have to pay for a one-time VA funding fee.
How Does Private Mortgage Insurance Work?
Just like any other insurance policy, private mortgage insurance requires that you make payments every month.
But unlike homeowners’ insurance, private mortgage insurance only protects the lender and not the homeowner. Here’s what you need to know about the workings of PMI:
- Getting PMI: Once your offer is accepted and your mortgage application is being processed, your lender will request a PMI policy on your behalf through their designated PMI provider.
- Paying PMI: It is common for your lender to inform you about the cost of the potential monthly PMI payments you’ll make and for how long. Remember that your PMI payments are in addition to your mortgage payments (Principal, Interest, Tax, and Insurance).
- Canceling PMI: This may seem strange, but you do not have to pay for PMIs for the entire life of the loan. Typically, you’ll stop making PMI payments on the date your principal balance reaches 78 percent of the original price of the property. Once your PMI is canceled, you’ll notice a reduction in the cost of your monthly mortgage payments.
How Much Does PMI Cost?
While there is no set-in-stone PMI cost, it is common for PMI rates to hover around 0.58 percent to 1.86 percent, according to a recent study by Urban Institute.
Popular mortgage provider Freddie Mac estimates that the average homebuyer spends between $30 to $70 per month on PMI payments for every $100,000 borrowed.
Generally, the private mortgage insurance you may have to pay will depend on the following factors:
- The size of the mortgage: The higher your mortgage, the more money you will pay for PMI.
- Down payment amount: Your down payment plays a significant role in determining the amount you pay in PMI premium. A smaller down payment equals higher risks on the part of the lender. So, it is common for your PMI to be higher to account for such risk.
- Your credit score: Your credit score and credit history will impact the amount you pay in PMI premium. If you’ve got a higher credit score in the range of 760 or greater, you’re more likely to receive the lowest PMI rates.
The type of loan you opt for can influence how much you pay in a private mortgage insurance premium.
For example, most mortgage experts believe that fixed-rate mortgages tend to come with a lower PMI due to the consistency of their rates over the life of the loan.
Finding out the potential cost of PMI before you take out a home loan can help you estimate how much house you can afford in relation to your finance.
How to Calculate Private Mortgage Insurance
Let’s say John purchased a house for $300,000 with a 15% down payment. So, if John’s lender charged him a PMI rate of 1.25%, below is how the numbers will turn out:
|Down Payment:||$45,000 (15% of $300,000)|
|Rate of PMI:||1.0%|
|Annual PMI Payment:||$2,550 (1% of the Total Loan Amount)|
|Monthly PMI Payment:||$212.50|
Is PMI Tax Deductible?
Private mortgage insurance is still tax-deductible. So, it’s still possible for you to deduct PMI from your taxes in 2021.
However, you may not be able to remove PMI from your taxes once your adjusted gross income reaches $100,000.
More importantly, you carefully decide if itemizing your deductions and including your PMI is beneficial than the necessary standard deductions.
Different Types Of PMI
There are a few types of private mortgage insurance:
- Borrower-paid mortgage insurance: Popularly referred to as BPMI, this type of PMI is part of your monthly mortgage bill. That is, your insurance premium is paid in addition to your principal balance, interest charges, taxes, and other expenses. Once received, the funds are disbursed monthly to the insurance provider.
- Lender-paid mortgage insurance: While lender-paid mortgage insurance may appear enticing, you’re still responsible for the insurance premium. However, instead of seeing the payment as a line item, you’ll have to pay back by accepting a higher interest rate or origination fee.
- Single-premium mortgage insurance: Instead of the traditional monthly payment of PMI, single-premium mortgage insurance lumps up the entire cost of the premium into a single payment.
- Split-premium mortgage insurance: Under split-premium mortgage insurance, you’ll pay a bigger upfront fee that covers some of the insurance cost in exchange for a reduction in your monthly mortgage bill.
When deciding on your private mortgage insurance type, you should endeavor to discuss your options with your lender for proper guidance.
How Do I Make PMI Payments?
PMI payment options differ by lenders. You may decide to make a single lump-sum payment each year or make the traditional monthly payments. Consult with your lender to find out if you have the liberty of choosing your PMI payment option.
Do all lenders require PMI?
Sorry to burst your bubble: Most conventional mortgage lenders will require PMI if your down payment is less than 20 percent.
Still, you can find low-down payment and PMI-free conventional loans that allow you to skip PMI even with a low-down payment.
An excellent example of a PMI-free conventional loan is the PMI Advantage from Quicken Loans(or Rocket Mortgage).
You can also take advantage of unconventional loans like FHA and VA that don’t exactly charge mortgage insurance.
For example, instead of PMI, FHA loans require borrowers to pay for its form of mortgage insurance known as mortgage insurance premium (MIP). Although MIP comes at a lower rate compared to PMI, there is no way to cancel it.
If you’re a Veteran or member of the Armed Forces, VA loansare an excellent way to avoid PMI payment.
However, you may have to pay a special funding fee typically 1.4% to 3.6% of your total loan amount.
How to Avoid Private Mortgage Insurance (PMI)
The only way to avoid PMI payment is to make a down payment of at least 20 percent of your potential home price.
While saving 20% or more for your down payment may seem difficult, it can be beneficial in the long run.
Another way to quickly hit the required 20% down payment and avoid paying private mortgage insurance is to opt for a less expensive house.
By purchasing a less expensive house, you can make a bigger down payment on your potential home purchase.
How to Get Rid of PMI
Below are a couple of things you can do to eradicate PMI forever:
Make Extra Mortgage Payments Every month
You could easily reach the 80% mortgage principal threshold faster and in less time by overpaying on your mortgage every month.
Remember that this may impact your finances since it requires you to find extra cash to cover the additional payments.
Get Your Home Appraised
One of the quickest ways to get rid of PMI is to keep track of your home value. Ask your lender for a new home appraisal if you think your home value has appreciated more than the 20% equity.
As long as your loan to value ratio (LTV) is less than 80% of the new appraisal, you can write to your lender and ask to cancel PMI.
Is PMI Based on Credit Score?
Yes, your credit score can influence the private mortgage insurance rate you receive. If your credit score is on the high side, you’re more likely to pay a lower monthly premium for PMI than when your credit score is low.
Does PMI Decrease Over Time?
Since annual PMIs are re-calculated every year, your PMI cost will decrease as you pay down your mortgage principal balance.
However, you can cancel PMI once your mortgage principal balance reaches 80% of your home’s original value.
Is There Any Advantage to Paying PMI?
While paying PMI may seem like an added financial burden, there are several advantages to paying for PMI premiums.
One of the significant advantages is that it allows you to buy a home without waiting to save for a 20% down payment.
Are First-Time Home Buyers Required to Get PMI?
Yes, first-time homebuyers are required to get PMI. Whether you’re a first-time or seasoned homebuyer, as long as your down payment is less than 20 percent for conventional mortgages, you are required to get PMI.
Bottom Line: What Is PMI?
While paying for PMI premium adds to your monthly mortgage bills, it can help you get your foot in the door of homeownership even with a low down payment.
If you’re a first-time homebuyer, check how much paying for PMI will affect your homeownership journey.
More importantly, before agreeing to a mortgage offer, you should ask your lender how they handle private mortgage insurance and what is expected of you in terms of payment.