Mortgage Insurance (also known as Private Mortgage Insurance, or PMI) protects a lender if a borrower defaults on their loan.
What is mortgage insurance?
Mortgage insurance is actually more for your lender’s benefit than it is for you.
So let’s backtrack a bit. Let’s say you’ve been saving up for a down payment on a home for the last few years. You’ve been talking to several banks and brokers to figure out whether or not you qualify for a loan, and how much you can get. In the end, the down payment you can afford is less than 20% of the loan amount you qualified for, so your mortgage company (aka, your lender) is requiring you to get mortgage insurance.
Your lender needs this extra protection since they’re taking a risk by accepting a lower down payment on your loan.
You’ll typically be paying your mortgage insurance premium monthly, along with your normal mortgage payment for your loan. Your monthly premium can range anywhere from $30-$70 per month for every $100,000 you borrowed. The cost of your policy depends on factors like your down payment or credit score, but is mostly influenced by the amount of the entire loan.
How to avoid paying PMI
Can you avoid this additional monthly cost?
Here’s a rule of thumb: The more you pay upfront, the less likely you are to need to pay PMI. The best way to avoid paying mortgage insurance is to have a down payment of at least 20% of your total loan.
Another option is to pay for lender-paid mortgage insurance, or LPMI. With LPMI, the lender incurs the monthly cost of the Mortgage Insurance, but at an even higher mortgage rate for the borrower. And unlike normal PMI, LPMI cannot be canceled.
There are a couple of ways to cancel PMI payments.
After paying your mortgage for a few years, you may be able to shed your PMI by refinancing your loan, which essentially means replacing your current loan with a new one, under different terms. Make sure to weigh the costs of refinancing against the cost of your existing payments to see if it makes sense financially.
You could also be eligible to end your PMI payments early if you have at least 20% equity in the home—meaning, you’ve paid for at least 20% of the original loan amount. So once your loan balance reaches 80% of the home’s original value, you can likely put in a request with your mortgage servicer to end your PMI early.