Understanding Private Mortgage Insurance (PMI)
PMI is a lender’s safety net, not yours. It’s an additional cost added to your mortgage when your down payment is less than 20%, designed to protect the lender if you default. Understanding PMI is crucial to managing your homebuying budget effectively.
What is PMI?
Private Mortgage Insurance is a policy required by lenders on conventional loans when your down payment is below 20% of the home’s purchase price. It’s paid by you, the borrower, but benefits the lender by reducing their risk.
Purpose of PMI
Protects lenders from losses in case of foreclosure, enabling lower down payments (e.g., 3-10%) for buyers.
How PMI Works
PMI is typically calculated as a percentage of your loan amount and varies based on factors like credit score and loan-to-value (LTV) ratio:
- Cost: 0.5% to 1.5% of the loan annually (e.g., $1,350-$4,050 on a $270,000 loan).
- Payment: Added to your monthly mortgage payment (e.g., $112-$337/month).
- Duration: Required until you reach 20% equity, then removable upon request.
- No Borrower Benefit: Unlike homeowner’s insurance, PMI doesn’t protect you—it’s for the lender.
PMI Cost Example
For a $300,000 home with a 10% down payment:
- Loan Amount: $270,000
- PMI Rate: 1% annually
- Annual PMI: $2,700
- Monthly PMI: $225
- Total PMI (5 years): $13,500 (if equity takes 5 years to reach 20%)
PMI Across Loan Types
PMI rules differ depending on your mortgage:
- Conventional Loans: PMI applies if down payment < 20%; removable at 20% equity (auto-canceled at 22%).
- FHA Loans: Requires Mortgage Insurance Premium (MIP)—1.75% upfront + 0.85% annually—often for the loan’s life unless 10%+ down.
- VA Loans: No PMI, but a funding fee (1.4%-3.6%) applies.
- USDA Loans: No PMI, but annual fees (0.35%) persist for the loan term.
Important
FHA MIP can’t be removed without refinancing to a conventional loan if your down payment is < 10%—plan ahead!
Strategies to Avoid or Eliminate PMI
You’re not stuck with PMI forever—here’s how to minimize or avoid it:
PMI Avoidance Checklist
Save for 20% Down
Avoid PMI entirely by putting 20% or more down (e.g., $60,000 on a $300,000 home).
Build Equity Faster
Pay extra toward principal or wait for home value appreciation to hit 20% equity, then request PMI removal.
Refinance Strategically
If your LTV drops below 80% due to rising home value, refinance to a conventional loan without PMI.
Piggyback Loan
Use an 80/10/10 loan (80% mortgage, 10% second loan, 10% down) to bypass PMI—compare interest costs.
Lender-Paid PMI (LPMI)
Lender covers PMI for a higher interest rate—crunch the numbers, as it may cost more long-term.
Pro Tip
Monitor your LTV ratio—request an appraisal if home values rise to cancel PMI sooner.
Cost-Benefit Analysis
Is PMI worth it? Consider these scenarios:
- With PMI: $270,000 loan, 10% down, $225/month PMI. Buy now, pay $13,500 over 5 years.
- Without PMI: Save 2 more years for 20% down ($60,000). Delay buying, but save $13,500 in PMI.
- Trade-Off: PMI lets you buy sooner (building equity vs. renting), but increases costs.
When PMI Ends
For conventional loans:
- Request Cancellation: At 20% equity (based on original value), you must initiate removal.
- Automatic Termination: At 22% equity or loan midpoint (e.g., 15 years on a 30-year loan).
- Process: Contact your lender, ensure payments are current, and possibly pay for an appraisal.