When you’re on the path to buying a home, you’ll come across a lot of new terms. One that often pops up is Private Mortgage Insurance, or PMI. While it might sound like just another fee, it’s actually a straightforward tool designed to help more people become homeowners, sometimes much sooner than they expected.
We’ll break down PMI in simple terms, explaining what it is, when you need it, and how you can manage it effectively. By the end, you’ll feel more confident about this common part of the homebuying journey.
What Is Private Mortgage Insurance?
Private Mortgage Insurance is an insurance policy that lowers the risk for your lender, not for you. When a homebuyer makes a down payment of less than 20% on a conventional loan, the lender takes on more financial risk. If the borrower can’t make their payments and the loan goes into default, PMI helps protect the lender from taking a major loss.
So, why is this a good thing for you? Because lenders take on more risk with smaller down payments, PMI gives them the confidence to approve loans they might otherwise deny. It’s often the key that opens the door to homeownership for those who haven’t saved up a large down payment.
When Is PMI Required?
The rule for PMI is specific: it applies when you get a conventional home loan and your down payment is less than 20% of the home’s purchase price.
For example, on a $680,000 home, a 20% down payment is $136,000. If you make a down payment of $68,000 (10%), your lender will almost certainly require you to pay PMI until you build up more equity in your property.
How Much Does PMI Cost?
The cost of PMI isn’t one-size-fits-all. It depends on your credit score, loan amount, and the size of your down payment. A better credit score and a larger down payment generally mean a lower PMI premium.
As a general guideline, you can expect PMI to cost:
- Annually: Between 0.46% and 1.5% of your total loan amount.
- Monthly: Around $30 to $70 per month for every $100,000 you borrow.
A Quick Calculation Example
Let’s imagine you’re buying a house for $600,000 and have a $60,000 down payment (10%). Your loan amount is $540,000. Since the down payment is less than 20%, PMI will be required. Say your lender quotes a PMI rate of 0.55% per year:
- Annual PMI Cost: $540,000 (Loan Amount) x 0.0055 (PMI Rate) = $2,970
- Monthly PMI Payment: $2,970 / 12 = $247.50
This $247.50 will be added to your monthly mortgage payment.
How Is PMI Paid?
You have a few different options when it comes to paying for PMI. Your lender can help you decide which is best for your financial situation.
- Borrower-Paid Monthly Premium: This is the most common method. The PMI cost is simply rolled into your monthly mortgage payment.
- Single-Premium PMI: You can opt to pay the entire PMI premium in one lump sum at your closing. This increases your upfront costs but removes the monthly PMI expense.
- Lender-Paid PMI (LPMI): In this scenario, the lender pays the insurance for you. In return, they’ll charge you a slightly higher interest rate on your mortgage for the life of the loan.
The Pros and Cons of PMI
While nobody loves an extra fee, PMI has some real advantages that are worth considering.
- Pro: Buy a Home Sooner. You don’t have to wait years to save up a 20% down payment.
- Pro: Start Building Equity. Every mortgage payment you make helps you build ownership in your home.
- Pro: It’s Temporary. PMI can be canceled once you meet certain requirements.
- Con: It Increases Your Monthly Payment. PMI is an added expense on top of your core mortgage payment.
- Con: It Protects the Lender. You pay for the policy, but the lender is the beneficiary.
PMI vs. FHA Mortgage Insurance (MIP)
It’s easy to confuse PMI with the insurance required for FHA loans, which is called the Mortgage Insurance Premium (MIP). They have a similar goal but function differently.
- PMI (Conventional Loans): Can be canceled once you reach 20% equity.
- MIP (FHA Loans): If you make a down payment of less than 10%, you’ll pay MIP for the entire loan term. It can’t be canceled unless you refinance into a conventional loan.
Because PMI can be eliminated, a conventional loan is often a better long-term financial choice for borrowers who qualify.
The Goal: Getting Rid of PMI
The best news about PMI is that you won’t be paying it forever. The federal Homeowners Protection Act gives you the right to cancel it.
1. Request Cancellation at 80% Loan-to-Value (LTV)
Once your mortgage balance drops to 80% of your home’s original appraised value, you can request your lender cancel your PMI. This is known as reaching an 80% loan-to-value (LTV) ratio. You must have a good payment history and be current on your loan.
2. Automatic Termination at 78% LTV
By law, your lender must automatically cancel your PMI on the date your loan is scheduled to reach 78% of the original value. This means you’ve built up 22% equity. This cancellation happens based on your original payment schedule, so as long as you are current on your payments, it will happen automatically.
4 Tips to Reduce or Eliminate PMI Faster
Want to minimize your PMI costs or get rid of the payment sooner? Here are a few practical strategies:
- Improve Your Credit Score. Before applying for a loan, take steps to boost your credit. A higher score often leads to a lower PMI rate.
- Make Extra Principal Payments. Paying a small extra amount toward your loan’s principal each month helps you build equity faster and reach the 20% threshold sooner.
- Get a New Appraisal. If home values in your neighborhood have gone up significantly, you might have enough equity to cancel PMI ahead of schedule. Talk to your lender about this option.
- Refinance Your Loan. If interest rates have dropped or your home’s value has increased, refinancing could help you eliminate PMI and potentially get a better interest rate.
Ready to Learn More?
Private Mortgage Insurance is a bridge that helps countless people achieve homeownership. Understanding how it works puts you in control of your financial journey. The best way to see how PMI might factor into your home purchase is by speaking with a professional. Our preferred lenders can walk you through different scenarios, provide exact cost estimates, and help you find the mortgage that works for you.
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