If you’re a first-time homebuyer you’ve surely been putting pencil to paper to estimate what your future mortgage payment, taxes, insurance, and maintenance will be on a new home. But there’s one expense that often catches buyers by surprise: private mortgage insurance (PMI).
So, what exactly is PMI, and how does it affect your home purchase? Let’s break it down.
What is private mortgage insurance (PMI)?
Private mortgage insurance (PMI) is an extra cost that protects the lender if you default on your mortgage. It’s typically required if you put down less than 20% when buying a home or if your equity drops below 20% when refinancing. PMI costs between 0.5% and 1.5% of your loan amount annually and is added to your monthly payment. However, unlike homeowners insurance, PMI does not cover you—it’s strictly for the lender’s protection.
When do you have to pay PMI?
If your down payment is less than 20%, PMI is non-negotiable for most loan types. The good news is that you can discontinue this payment when you have paid off 20% of the loan’s principal amount – the equivalent of that 20% down payment. At that point, you can ask the lender to remove the PMI from your mortgage payments.
Lenders are not obligated to cancel PMI automatically until you reach 22% equity based on the original loan balance. However, you can take action earlier by requesting removal at 20% equity—so it’s worth keeping an eye on your loan balance.
How to calculate PMI
You can estimate your monthly PMI cost using this formula:
(Loan amount x PMI rate) / 12 = Monthly PMI payment
If your PMI comes in at a rate of 1%, here’s how you’d calculate for a mortgage of $400,000:
$400,000 x 1% = $4,000 per year
$4,000 / 12 monthly payments = $333 per month
This amount you pay in PMI would be added to your regular monthly mortgage payment.
What factors impact your PMI payment?
Calculating your monthly PMI cost may seem pretty straightforward, but there are a few key factors that can impact how much you actually pay.
Home value and loan amount
These two factors go hand-in-hand since the size of the loan is largely determined by the value of the home you’re buying. In most cases, a more expensive house requires a larger loan, which increases the PMI cost.
Credit score
Your credit score is another key factor in determining your monthly PMI payment. Homebuyers with low credit scores will have a higher rate as financial institutions need to protect themselves when lending to higher-risk borrowers.
Type of loan
Homebuyers can choose between fixed-rate and adjustable-rate mortgages. Lenders view the adjustable variety as higher risk, and will usually charge a higher rate as a result
Loan term
The term of the loan also factors into a lender’s risk calculation. In most cases, homebuyers can choose either a 15-year or 30-year mortgage. Shorter-term loans are viewed as lower risk for lenders, so this option can lower your PMI payment. Conversely, a longer-term loan will result in a higher payment. Most lenders require a higher credit score to qualify for a 15-year mortgage.
How to avoid paying for PMI
1. Make a 20% down payment
The simplest way to avoid PMI is to put down at least 20% upfront. However, if that’s not feasible, explore the options below.
2. Look for a lender who doesn’t require PMI
Some credit unions or lending institutions may not insist on PMI for individual applicants. For example, they may waive the PMI requirement if the borrower moves all of their savings and checking accounts to the lender’s institution. A lender may also waive PMI if the borrower has a stellar credit profile.
Other lenders offer portfolio loans – a direct private loan issued in-house, rather than sold to a third-party lender, like Fannie Mae or Freddie Mac. Terms for this type of loan may involve smaller down payments (10-15%) with no PMI requirement.
3. Piggyback the loan
In this scenario, you’d take out a separate small loan for the 20% down payment and proceed with a conventional mortgage. The downside is that the smaller loan will typically have a higher interest rate than the mortgage loan. Until 2021, homeowners could deduct PMI interest on their tax return, but that provision has since expired.
4. Apply for the Affordable Loan Solution
This loan partnership between Self-Help Ventures Fund and Freddie Mac makes loans available to low- to moderate-income homebuyers and allows for a 3% down payment with no PMI payments.
5. Pursue a VA loan if you qualify
Qualified veterans can finance 100% of their home purchase with no PMI requirement. However, it’s good to note there may be additional upfront fees involved.
6. If you are a physician, you may qualify for a particular physician loan
Some lenders offer specific loans to physicians with new practices and no extensive work history. These borrowers often carry significant student debt, which skews their debt-to-income ratio. These loans don’t require PMI, even with a downpayment of less than 20%.
7. Look into first-time homebuying programs in your area
Take advantage of first-time homebuyer programs that vary by state, territory, county, and city. These programs assist first-time homebuyers with down payment assistance and closing costs which can help them avoid paying PMI.
It’s worth shopping around with different lenders and homebuying programs that will work with your financial situation and hopefully not require you to pay for PMI.
Private mortgage insurance FAQs
Does private mortgage insurance protect homebuyers?
Private mortgage insurance is not intended to protect homebuyers. Its purpose is to protect lenders in case the borrower defaults on their loan.
Is PMI tax-deductible?
PMI is no longer tax-deductible due to the expiration of the Further Consolidated Appropriations Act in 2021.
How do I make my PMI payment?
The most common way to pay for PMI is through monthly payments. However, you may also choose to pay the entire premium up-front. Keep in mind that paying up-front means you won’t be eligible for a refund.
Is PMI removed automatically?
PMI is not always removed automatically. While lenders are required to cancel PMI at 78% loan-to-value (LTV)—as long as you’re current on payments—you can request removal earlier once you reach 80% LTV. To remove it at 80%, you’ll need to contact your lender and formally request cancellation.
Can I refinance to get rid of PMI?
Yes! If your home has appreciated in value and your equity has reached at least 20%, you may be able to refinance into a new loan without PMI. However, factor in closing costs to ensure refinancing makes financial sense.
Does PMI apply to all loan types?
No, PMI is typically required for conventional loans with less than 20% down. FHA loans have a different type of mortgage insurance (MIP), which has different rules and may be required for the life of the loan. VA loans do not require PMI.
Can I pay PMI upfront instead of monthly?
Yes, some lenders offer an upfront PMI payment option. This means you pay PMI as a lump sum at closing instead of adding it to your monthly mortgage payment. However, if you refinance or sell the home early, you typically won’t get a refund.
What happens if I stop paying PMI?
PMI is not optional if your loan requires it. If you stop making payments, your lender could report late payments to credit bureaus, charge late fees, or even foreclose on your home if payments aren’t made.