What Is Private Mortgage Insurance (PMI)?

What Is Private Mortgage Insurance?

Private mortgage insurance is a type of mortgage insurance lenders require on a conventional mortgage when you put less than 20% down. A conventional mortgage is any home loan that isn't backed by the government.

Lenders prefer to issue loans for no more than 80% of the market value of the home because a higher loan-to-value (LTV) ratio puts them at more risk. But coming up with the 20% down payment lenders prefer is difficult for many borrowers, especially those trying to enter the housing market for the first time. In light of this, lenders devised PMI as a way to protect themselves on loans with LTV ratios greater than 80%.

Mortgages are secured by the home itself, but if a borrower fails to pay and the lender is forced to take the home through foreclosure, there can be steep costs associated with re-selling it. Lenders can use down payments and PMI to help cover those expenses.

Learn more: How Your Down Payment Affects Your Mortgage

Tip: Private mortgage insurance is different from homeowners insurance, which protects you from loss or damage associated with your home. PMI, on the other hand, protects lenders from the costs associated with a mortgage default.

When Is PMI Required?

PMI is typically required on a conventional home loan if you put less than 20% down on the purchase, or if you refinance your existing mortgage into a loan with an LTV ratio over 80%.

When lenders issue loans with LTV ratios greater than 80%, they require you to purchase mortgage insurance to cover the difference between the amount you put down at closing and a 20% down payment. Here's how LTV is calculated:

Example: On a $300,000 home, a borrower putting down 20% ($60,000) would require a loan of $240,000, yielding an LTV ratio of 80%. If a borrower put 15% down on the same home ($45,000), they would require a $255,000 loan—an LTV ratio of 85%.

Coming up with at least 20% of the home's value as a down payment can help you avoid the PMI requirement on a conventional loan.

Types of PMI

There are several types of PMI, and each one structures your payments differently:

• Monthly: The most common PMI payment arrangement divides your annual PMI premium into 12 monthly payments, which are added to your monthly mortgage bill.
• Upfront: You pay for PMI in a lump sum as part of your closing costs. This could lower your monthly payments, but you should check to see if the single-premium PMI option is refundable, especially if you anticipate a possibility of selling the home within one year.
• Split premiums: You purchase a portion of the PMI policy upfront and cover the rest in payments added to your monthly mortgage statements. This is a fairly uncommon arrangement.
• Lender-paid PMI: With lender-paid PMI, the lender covers the PMI premium but shifts the cost to you in the form of higher interest rates. Lender-paid PMI can be more costly because it's there for the life of the loan; you can't get rid of it when you reach an 80% LTV, which you can do in other cases.

How Much Does PMI Cost?

Broadly speaking, PMI may cost between 0.3% and 2% of the original loan amount per year when you pay monthly. But the individual cost of PMI depends on several factors, which may include:

• The total loan amount
• Your credit score
• The specific LTV ratio on the mortgage and the size of your down payment

Do You Choose Your Own PMI?

No, the borrower doesn't get to select a PMI provider. When PMI is required, the lender secures a policy provided by a private insurance company. Borrowers have no vote in the choice of PMI provider, so there's no opportunity to compare pricing.

Is Paying PMI Worth It?

Private mortgage insurance can be a great means of getting into a home without having to scrape together a full 20% down payment. If you're ready to own a home, you don't see a 20% down payment as a reality anytime in the near future and you're willing to pay the cost of PMI to get into a home, it could be a good choice for you.

That said, some people may decide that PMI isn't an expense they want to take on. It's an extra cost that adds to the price of owning a home. If you're already worried about ongoing loan payments and other homeownership costs, PMI could increase that stress.

How to Avoid PMI on a Mortgage

If you want to avoid PMI, consider these options:

• Look at alternative types of mortgages. You could seek government-insured loans issued by the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA) or U.S. Department of Agriculture. Each has significant borrowing restrictions, but if you qualify, you can avoid PMI. These government-backed mortgages may come with their own types of mortgage insurance, or you may be required to pay upfront guarantee fees or funding fees.
• Save up for a larger down payment. It may be worth waiting longer to buy a home and saving up more for a house in the meantime, with a goal of getting to at least a 20% down payment by the time you purchase. Just keep in mind that, in some markets, housing prices will be rising as you save, meaning you may need to increase your saving goal.
• Search for less expensive homes. Use savings you already have as a down payment on a smaller loan. If you've saved enough, consider purchasing an older or smaller home in your area, looking around in other markets where housing costs are lower, or perhaps investigating condominiums or co-op apartment units. Getting into less home than you want right now might require some compromises, but it could also set the stage for trading up to a bigger property within the next five to 10 years.

Learn more: Ways to Save Money on Your Mortgage

How Long Do You Have to Pay for PMI?

Generally speaking, you'll need to continue paying PMI until your LTV ratio is lower than 80%. Your lender should automatically remove your PMI when your loan reaches a 78% LTV ratio, but you also have the right to request PMI removal when you reach 80% LTV.

How long will it take you to get to an 80% LTV? The answer depends on several factors:

The Size of Your Down Payment

The closer your original down payment was to 20%, the sooner you'll get to 80% LTV.

Example: For a $300,000 home, if you put down 10% on a 30-year loan at 4.5% interest, it would take just over six years to reach 20% equity. With a 5% down payment, it would take more than eight years. If you haven't saved a 20% down payment for a home purchase, you may want to reconsider how much money you need to buy a home in order to avoid PMI payments.

The Size of Your Monthly Payments

You can speed up accumulation of equity (and your arrival at 80% LTV) by "overpaying" your mortgage each month. In addition to enabling you to end PMI payments sooner, this practice can save you interest costs over the life of the loan.

Prepaying your mortgage comes with some tradeoffs, however, so consider this option carefully before you proceed and check with your lender to find out their policy on extra payments.

Learn more: How to Pay Off Your Mortgage Early

Changes in Appraised Value

Your home's appraised value can change with market conditions. If you buy in an area with rising home prices, market appreciation on your property could help you get to 20% equity even sooner. By contrast, declining neighborhood property values could prolong the time needed to reach 80% LTV.

Tip: Before PMI can be removed, you may need to pay for a new appraisal. Appraisals typically cost somewhere from $300 to $500, though prices could be more based on where you live, the size of your home and current real estate market conditions.

Learn more: How to Get Rid of Private Mortgage Insurance (PMI)

Can a Good Credit Score Help Me Avoid PMI?

If you have good credit, you could qualify for an 80-10-10 mortgage, also sometimes called a piggyback loan. A piggyback loan can help you avoid PMI while putting just 10% of your funds down.

To make this possible, an 80-10-10 loan works by taking out a mortgage for 80% of the property value, and then a second loan to use as a 10% down payment. You combine that 10% loan with your own 10% down payment to equal a total 20% down payment.

Both the 80% loan and the 10% loan are secured by the home, so defaulting on either one could result in foreclosure.

Lenders are highly selective about issuing 80-10-10 loans. In addition to a great credit history, you'll need to meet any other lender requirements, which may include:

• A strong record of regular employment
• Minimum requirements for savings and other assets
• A debt-to-income ratio (DTI) below 43%

These requirements can make an 80-10-10 loan difficult to qualify for. But, if you do think you meet the requirements, it may be an option worth investigating.

Learn more: Are Piggyback Loans a Good Idea?

The Bottom Line

Many homebuyers see private mortgage insurance, and the hundreds of dollars per month it typically costs, as little more than a necessary evil. But by allowing homebuyers to purchase a home with a down payment of less than 20%, PMI lifts a major roadblock for many would-be homebuyers. It's a tool worth understanding, and it might help you get into the home of your dreams.