Private Mortgage Insurance
Private mortgage insurance (aka PMI) is required when a homebuyer pays a downpayment of 20% or less on their mortgage. This insurance protects the lender in case the borrower can’t repay their home loan.
When is private mortgage insurance required?
Private mortgage insurance protects lenders in case the borrower can’t afford their mortgage payments. The lender will probably require that the borrower pay mortgage insurance if they take out a mortgage and put 20% or less down for their down payment. Or, in other words, if the loan-to-value ratio is 80% or higher. Loan-to-value ratio is determined by dividing your mortgage loan amount by the appraised property value of your home.
When a mortgage lender gives you a loan, they’re essentially investing in you. They trust that you’ll pay back the loan, with interest. A down payment is one way borrowers establish trust with a lender, so when a down payment is 20% or lower, the lender might want some additional insurance to protect their “investment.”
It’s worth noting that private mortgage insurance does not protect you from foreclosure if you fail to make your loan payments.
Who tends to use PMI, and what are the pros and cons?
PMI makes it possible for more people to become homeowners, including those who don’t have lots of cash on hand for a large down payment.
That said, some borrowers who pay PMI might have the cash for a larger down payment, but would rather put those funds towards renovations, repairs, furniture, and other expenses related to their new home.
While PMI can open some doors, it will add to your monthly mortgage payment. Also, depending on the type of PMI you choose, you might need to pay interest on it.
The good news is that oftentimes, you only need to pay PMI until you’ve reached 20% equity in your home. For example, if you buy a $400,000 home, and you put down a $40,000 down payment (10%), once you’ve paid off a total of $80,000 (20%) of the principal loan amount, you’re potentially off the hook from private mortgage insurance.
Home loans backed by the Department of Veterans Affairs, aka VA loans, do not require private mortgage insurance.
How much does private mortgage insurance cost?
On average, PMI premiums cost between 0.58%-1.86% of the original loan amount per year. There are many factors that determine how much you will ultimately pay on your PMI, including:
- How much you’re spending on your home
- Your down payment or loan-to-value ratio
- Your lender
- Your loan term
- Your mortgage insurance rate (determined by the lender based on your credit score, debt-to-income ratio, and more)
Let’s say you’re buying a $400,000 home, and are putting down a $40,000 (10%) down payment. The lender offers you a 30-year mortgage with a 4.5% interest rate, and a private mortgage insurance rate of 0.75%. Here’s how your mortgage payments would be broken down with PMI:
Total monthly payment without PMI: $2,257 (includes principal loan amount, APR, taxes, and homeowners insurance)
Monthly PMI cost: $225
Total monthly payment with PMI: $2,482
Total PMI paid: $16,527 (until you reach 20% home equity)
What are the different types of private mortgage insurance?
Borrower-paid mortgage insurance (BPMI): This is the most common form of private mortgage insurance. With BPMI, your lender simply rolls your private mortgage insurance premium into your monthly mortgage payment (as demonstrated above). After you have reached 22% equity in your home, the lender will automatically cancel your BPMI, but after you’ve reached 20% equity, you can manually cancel PMI payments through your lender. It pays to be proactive! (And FYI, if you refinance your mortgage, you could end up getting out of BPMI faster.)
Single-premium mortgage insurance (SPMI): With SPMI, you pay for your private mortgage insurance at closing, in a lump sum. This can be done in cash or it can be added to your mortgage loan financing. This can help you save money on your monthly mortgage payments—but if you choose to borrow the money through your mortgage lender, you’ll have to pay back that loan with interest for as long as you have the mortgage.
Lender-paid mortgage insurance: So, the name is a bit of a misnomer. Technically, the mortgage lender pays the insurance premium, but actually you pay it, just in the form of a higher interest rate on your mortgage. (Sounded too good to be true, right?) In this scenario, even when you have over 20% equity in your home, your interest rate won’t go down, because the PMI is built directly into your loan balance. But depending on your insurance rate, you may still end up paying less on PMI in the long run.
Split-premium mortgage insurance: This is a hybrid of BPMI and SPMI. You pay part of your PMI premiums up front as a lump sum, and the rest you pay monthly as a part of your monthly mortgage payments.
Federal home loan mortgage protection: Government-backed home loans through the Federal Housing Administration (FHA) are designed to help people become homeowners, especially if they are first-time homebuyers and/or have a lower credit score. If you take out a mortgage through the FHA, and put down 10% or less down, you’ll need to pay a different form of private mortgage insurance, called mortgage insurance premium (MIP). MIP requires both upfront and monthly payments, and can only be removed if you refinance.