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What is Private Mortgage Insurance (PMI) and What Are My Options?
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It’s a myth that you need to put down 20% of a home’s purchase price to get a mortgage. Lenders offer numerous loan programs with lower down payment requirements to fit a variety of budgets and buyer needs. If you go this route, though, expect to pay for private mortgage insurance, or PMI. This added expense can drive up the cost of your monthly mortgage payments and, overall, makes your loan more expensive. However, it’s almost unavoidable if you don’t have a 20% or more down payment saved up.
What is PMI?
PMI is a type of mortgage insurance that buyers are typically required to pay for a conventional loan when they make a down payment that is less than 20% of the home’s purchase price. Many lenders offer low down payment programs, allowing you to put down as little as 3%. The cost of that flexibility is PMI, which protects the lender’s investment in case you fail to repay your mortgage, known as default. In other words, PMI insures the lender, not you.
PMI helps lenders recoup more of their money in a default. The reason lenders require the coverage for down payments below 20% of the purchase price is because you own a smaller stake in your home. Mortgagers are lending you more money up front and, therefore, stand to lose more if you default in the initial years of ownership. Loans insured by the Federal Housing Administration, or FHA loans, also require mortgage insurance, but the guidelines are different than those for conventional loans (we’ll cover that later).
How Much Does PMI Cost?
In general, you’ll pay between $40 and $80 per month for every $100,000 borrowed, according to Freddie Mac, a government-sponsored enterprise that buys and sells mortgages on the secondary mortgage market. Keep in mind this amount can vary based on your credit score and your loan-to-value ratio – the amount you borrowed on your mortgage compared to the home’s value.
In years past, you were allowed to deduct the cost of PMI from your federal taxes. For 2017 and going forward, Congress decided not to renew that provision, so you can no longer deduct PMI payments on your annual taxes. (Actually, they later restored the deduction just for 2017. Starting in 2018, it's gone.)
How Do I Pay for PMI?
You have two options to pay for PMI: a one-time, up-front premium paid at closing or monthly premiums. In many cases, lenders roll PMI into your monthly mortgage payment as a monthly premium. When you receive your loan estimate and closing disclosure documents, your PMI amount will be itemized in the Projected Payments section on the first page of each document.
Another option is to pay for PMI as one of your closing costs. On the loan estimate and closing disclosure forms, you’ll find this premium on page 2, section B. The drawback of this option, though, is you likely won’t be refunded this amount if you move or refinance your mortgage. In some cases, you may pay both up-front and monthly premiums.
Can I Cancel PMI?
The good news is you won’t pay PMI for the entire duration of a conventional loan.
The federal Homeowners Protection Act eliminates PMI in one of three ways:
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borrower-initiated PMI cancellation
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automatic PMI termination
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final PMI termination
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Borrower-Initiated PMI cancellation
You can request PMI cancellation once your loan-to-value ratio – the amount of your loan balance divided by the home’s market value –falls below 80% of the home’s original appraised value (or sooner, if your home’s value appreciates before then). Lenders list this scheduled date on the PMI disclosure form, which you likely received as part of your closing documents.
To cancel PMI, you’ll need to:
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Make your request in writing.
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Be current on your monthly mortgage payments.
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Have a positive payment history (no more than one payment that was 30 days late in a 12-month period or no more than one payment that was 60 days late in a 24-month period, according Fannie Mae and Freddie Mac).
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Verify you have no junior liens (such as a second mortgage).
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Automatic PMI termination
Another way to end PMI is known as automatic PMI termination, which kicks in on the expected date that your remaining mortgage balance hits 78% LTV. By law, lenders are required to cancel PMI automatically by this date. The same conditions for borrower-initiated PMI cancellation (on-time payment history and no liens) also apply here. If you’ve had late payments, your lender will not cancel PMI until your payments become current.
Final PMI termination
Finally, there’s something called final PMI termination. This is when a lender must automatically end PMI the month after your loan term hits its midpoint on a repayment schedule – even if you haven’t reached 78% LTV. For example, if you have a 30-year fixed loan, the midpoint would be after the 15-year mark. Again, you must be current on your payments to qualify. This type of PMI cancellation usually applies to loans with special features, such as balloon payments, an interest-only period, or principal forbearance.
How Does My Home’s Value Factor into PMI Cancellation?
Your eligibility to cancel PMI is also influenced by whether your home’s value has appreciated or depreciated over time. If it increases, you can cancel PMI sooner than expected; if it decreases, you will wait longer than expected to cancel PMI.
Before canceling PMI, a lender will determine your home’s current market value by a Broker Price Opinion (performed by a real estate agent who values your home based on the value of comparable homes in your neighborhood), a certification of value, or another type of property appraisal
If your home’s value has fallen due to a market downturn, your lender will likely deny your PMI cancellation request unless your home’s value is based on a new appraisal and you pay down the remaining loan balance to the 80% LTV of the new appraised value.
On the other hand, your home’s value might increase faster than anticipated, either due to market conditions or because you’ve remodeled it, meaning you might reach the 80% LTV threshold early. In that case, you can request PMI cancellation ahead of time, and your lender will order an appraisal to confirm the home’s current value. (Note: You’re responsible for paying for the property appraisal, which can cost anywhere from $300 to $400. This amount may vary depending on the home’s size and location.)
How Can I Avoid PMI?
Get a conventional loan without PMI
Some lenders offer their own conventional loan products without required PMI; however, they tend to charge higher interest rates to protect themselves if you default on your loan. In the long run, that can be more or less expensive than paying PMI, depending on how long you stay in your home or how long you keep the same mortgage.
This is where comparison shopping for a mortgage can help. Look at the interest rates offered for non-PMI loans versus those with PMI. Calculate the difference between the two to see how much more you’ll pay for a loan without PMI. Is that amount less than PMI payments you’ll make until you reach the 80% LTV ratio for cancellation? Remember, home values could rise or fall, affecting the length of time you might pay PMI.
Make a larger down payment
Putting down 20% of a home’s purchase price eliminates PMI, which is the ideal way to go if you can afford it. In addition to saving regularly for a down payment, consider buying a less expensive home. A more conservative house-hunting budget will lower the amount needed to make a 20% down payment.
Consider a second mortgage
Some lenders recommend using a second “piggyback” mortgage to avoid PMI. This can help lower initial mortgage costs rather than paying for PMI. It works like this: You take out a first mortgage for most of the home’s purchase price (minus your down payment amount). Then you take out a second, much smaller mortgage for the remainder of the home’s purchase price, less the first mortgage and down payment amounts. As a result, you avoid PMI and have combined payments less than the cost of the first mortgage with PMI.
However, a second mortgage generally carries a higher interest rate than a first mortgage. The only way to get rid of a second mortgage is to pay off the loan entirely or refinance it (along with the first mortgage) into a new standalone mortgage, presumably when the LTV reaches 80% (to avoid PMI). However, these loans can be costly, particularly if interest rates increase from the time you take out the initial loan and when you’d refinance both loans into one mortgage. Don’t forget you’ll might have to pay closing costs again to refinance both loans into one loan.
FHA Mortgage Insurance Premium (MIP)
If you can’t qualify for a conventional loan product, you might consider an FHA loan. Like some conventional loan products, FHA loans have a low-down payment option – as little as 3.5% down – and more relaxed credit requirements.
Lenders require mortgage insurance for all FHA loans, which are paid in two parts: an up-front mortgage insurance premium, or UFMIP, and an annual mortgage insurance premium, or annual MIP. Both costs are listed on the first page of your loan estimate and closing disclosure.
UFMIP
The UFMIP is 1.75% of the loan amount. You can pay it at up-front at closing or it can be rolled into your mortgage. If you opt to include UFMIP in your mortgage, your monthly payments will be higher and your total loan costs will go up.
Annual MIP
In addition to the UFMIP, you’ll pay an annual MIP, which is divided into equal monthly installments and rolled into your mortgage payments. Depending on your loan term and size, you’ll pay 0.45% to 1.05% of the loan amount.
How to Cancel FHA MIP
If you put 10% or more down, annual MIP can be canceled after the first 11 years of your loan. However, unlike conventional loans, FHA loans with a down payment below 10% require you to pay annual MIP for the life of the loan. If you fall into the latter camp, the only way to eliminate MIP payments is to refinance into a conventional loan, once your LTV ratio is low enough to qualify for a conventional mortgage without PMI.
The Bottom Line
If you don’t have a lot of cash saved for a down payment, paying PMI is a tradeoff you’ll make to borrow more money. You’re not alone if you choose this path. These days, most homebuyers are making down payments below 20%. In 2017, the median down payment on a home was 10%, according to a survey by the National Association of Realtors.
As you apply for mortgages, look carefully at loan estimates to compare how much you’ll pay for a loan with PMI. A loan that might not require PMI but comes with a higher interest rate. With few exceptions, PMI is difficult to avoid if you need a loan with a low down payment, but there is light at the end of the tunnel: You won’t pay PMI for the life of the loan.
https://www.investopedia.com/mortgage/mortgage-guide/mortgage-insurance/