Orlando Harmon
Private mortgage insurance (PMI) is an extra expense for borrowers who take out a conventional loan with a down payment of less than 20% of the purchase price. PMI is arranged by the lender and provided by private insurance companies. It protects the lender, not the borrower, in the event that the borrower falls behind on their payments. The requirement to buy PMI also applies to refinancing a conventional loan when the borrower's equity is less than 20% of the value of their home. PMI can help borrowers qualify for a loan that they might not otherwise be able to get, but it increases the cost of the loan.
| Characteristics | Values |
|---|---|
| Definition | Private Mortgage Insurance (PMI) is a type of mortgage insurance that compensates the lender in the event that the borrower fails to make their payments. |
| Who pays for it? | The borrower pays for PMI, although it protects the lender. |
| When is it required? | PMI is required when the down payment on a conventional loan is less than 20%. It is also typically required for Federal Housing Administration (FHA) and U.S. Department of Agriculture (USDA) loans. |
| Cost | The cost of PMI varies depending on the size of the loan, credit score, and other factors. It is generally cheaper for borrowers with good credit. |
| Payment options | PMI can be paid upfront as a one-time premium or included in monthly mortgage payments. There are also hybrid options where a portion is paid upfront and the rest is paid monthly. |
| Cancelling PMI | PMI can be cancelled once the borrower has built up at least 20% equity in their home or when the mortgage balance drops to 78% of the home's original value, whichever comes first. |
| Alternatives | Alternatives to PMI include lender-paid mortgage insurance (LPMI), where the cost is incorporated into the loan's interest rate, and "piggyback" second mortgages. |
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What You'll Learn
Private mortgage insurance (PMI)
PMI is not required for all types of mortgages, only for those with a down payment of less than 20%. If you are able to make a 20% down payment, you may not be required to pay PMI and you may also receive a lower interest rate. Additionally, PMI is not permanent and can be cancelled once your mortgage balance reaches 78%-80% of your home's value, or when you are halfway through your loan term.
PMI can help borrowers qualify for a loan that they might not otherwise be able to get. It lowers the risk to the lender of making a loan, allowing them to offer loans to borrowers who may not qualify otherwise. However, it increases the cost of the loan for the borrower. When considering PMI, it is important to compare the total costs of different options to determine the best deal.
There are alternatives to PMI, such as a "piggyback" second mortgage or a loan from the Federal Housing Administration (FHA) or the U.S. Department of Veterans Affairs (VA). FHA loans require mortgage insurance premiums (MIP), which are paid to the FHA and cost the same regardless of credit score. On the other hand, VA-backed loans do not require monthly mortgage insurance premiums but do have an upfront "funding fee".
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PMI rates and costs
The cost of Private Mortgage Insurance (PMI) depends on several factors. The most important of these is the size of your down payment. Typically, you need to make a 20% down payment to avoid paying PMI on a conventional mortgage. The closer your down payment is to 20%, the less PMI you will pay.
Other factors that affect your PMI rate include your credit score, the total mortgage amount, and the type of mortgage. A higher credit score will generally lead to a lower PMI cost, as this is seen as lower risk. Adjustable-rate mortgages carry a higher risk for lenders, so your PMI might be more expensive than with a fixed-rate loan.
PMI typically costs between 0.2% and 2% of your loan amount per year. The Urban Institute estimates the average monthly cost of PMI to be 0.46% to 1.5% of the loan amount. For a $200,000 loan, this would mean a PMI of $60 per month at a rate of 0.36% annually.
There are three main types of PMI, each with its own payment structure:
- Borrower-paid PMI: The most common type, where the premiums are part of your monthly mortgage payment.
- Lender-paid PMI: The lender pays the premiums, but you will pay a higher interest rate on the loan.
- Single-premium PMI: A one-time, upfront premium payment. This can also be rolled into the loan itself.
You can use a PMI calculator to estimate the total cost of PMI over the life of your mortgage.
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Mortgage insurance for Federal Housing Administration (FHA) loans
Mortgage insurance is typically required for Federal Housing Administration (FHA) loans. FHA loans are mortgages insured by the government and issued by lenders approved by the FHA. They are designed to help low- to moderate-income families attain homeownership, and they are particularly popular with first-time homebuyers.
FHA loans require a lower minimum down payment than many conventional loans, and applicants may have lower credit scores than what is usually required. Due to the lower down payment, borrowers who get an FHA loan are required to pay for mortgage insurance, which compensates for the lower down payment in the event that the lender has to foreclose. The mortgage insurance premium (MIP) includes an upfront cost, paid as part of the closing costs, and a monthly cost included in the monthly payment. The upfront premium is typically 1.75% of the base loan amount. FHA mortgage insurance rates are generally cheaper than private mortgage insurance (PMI) rates for borrowers with good credit.
Mortgage insurance is designed to protect the lender in the event that the borrower fails to make their payments. While it does not provide any protection for the borrower, it does allow borrowers who may not otherwise qualify for a loan to get one.
Once you've paid off a significant portion of your loan, you may be eligible to cancel your mortgage insurance, which would remove the monthly cost.
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$8.23
Cancelling mortgage insurance
Mortgage insurance for conventional loans is called private mortgage insurance (PMI). PMI is usually required if you bought a home with less than a 20% down payment. It is possible to cancel PMI once you have paid down your mortgage to a certain point, which is typically when your principal balance reaches 78-80% of the original value of your home. To cancel PMI, you must be current on your payments, and you may need to submit a written request to your mortgage servicer.
Mortgage insurance for loans insured by the Federal Housing Administration (FHA loans) is called a mortgage insurance premium (MIP). FHA borrowers are required to pay MIP, regardless of the size of their down payment. The ability to cancel MIP depends on the origination date of the loan. If the loan was originated between January 2001 and June 3, 2013, MIP can typically be cancelled when a loan-to-value (LTV) ratio of 78-80% is reached. For loans originated after June 3, 2013, with a down payment of at least 10%, MIP will be cancelled after 11 years. However, if the down payment was less than 10%, MIP will need to be paid for the life of the loan. If your loan doesn't qualify for automatic cancellation, refinancing may be an option to eliminate MIP.
Other Considerations
It's important to note that the requirements for removing mortgage insurance can vary depending on the type of property and the lender. For multi-unit properties or investment properties, the rules for cancelling mortgage insurance may be different. Additionally, mortgage protection insurance (MPI), also known as mortgage life insurance, is optional coverage that is separate from PMI or MIP. MPI pays off your home loan if you pass away before the loan is fully paid off.
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Mortgage insurance for U.S. Department of Agriculture (USDA) and VA loans
When taking out a mortgage, some form of mortgage insurance is usually necessary. Conventional loans require private mortgage insurance (PMI), while Federal Housing Administration (FHA) loans require a mortgage insurance premium (MIP). USDA and VA loans, however, are exempt from these requirements, offering borrowers a unique benefit.
USDA loans are mortgages backed by the US Department of Agriculture. They are designed for homebuyers seeking properties in rural or suburban areas, with income limits that vary based on location and family size. While USDA loans do not technically require mortgage insurance, they do carry similar fees. There is a 1% upfront guarantee fee, which can be included in the loan, and an annual fee of 0.35% of the loan balance, paid monthly for the life of the loan. These fees help offset the risk assumed by lenders in low or no down payment mortgage programs. USDA loans offer competitive rates, flexible credit requirements, and the possibility of zero down payment, making them an affordable option for eligible borrowers.
VA loans, provided by private companies and backed by the Department of Veterans Affairs, offer a range of benefits for eligible veterans and their spouses. Notably, VA loans do not require private mortgage insurance (PMI) or any other type of ongoing mortgage insurance. Instead, borrowers pay a one-time VA funding fee, typically ranging from 0.5% to 3.3% of the loan amount. This fee helps sustain the VA benefits program for future borrowers and can be financed into the loan to avoid upfront costs. The absence of ongoing mortgage insurance on VA loans significantly reduces costs for borrowers, enhancing their purchasing power.
While USDA and VA loans differ in their specific requirements and target audiences, they both offer attractive alternatives to conventional mortgages by eliminating the burden of ongoing mortgage insurance premiums. These loans provide financial flexibility and accessibility, making homeownership more attainable for qualified individuals.
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Frequently asked questions
Private mortgage insurance is a type of insurance that you might need to buy if you take out a conventional loan with a down payment of less than 20%. It protects the lender if you stop making payments.
The cost of PMI depends on the size of your home loan, your credit score, and other factors. The higher your credit score, the lower your PMI cost. The average monthly cost of PMI is 0.46% to 1.5% of the loan amount.
You pay PMI premiums to your lender, usually on top of your monthly mortgage payment.
Yes, you can cancel PMI once you have built up at least 20% equity in your home.
