When making a down payment of less than 20% on your home purchase, your lender may require you to purchase private mortgage insurance (PMI).
Key Takeaways
- PMI is required for conventional loans when the down payment is less than 20%.
- PMI typically appears as part of your monthly mortgage payment, ranging from $30 to $70 for every $100,000 borrowed.
- Once you reach 20% equity in your home, PMI payments can cease.
- There are five primary types of mortgage insurance: borrower-paid, single-premium, lender-paid, split-premium, and federal home loan mortgage insurance.
What Is Private Mortgage Insurance (PMI)?
When purchasing a home, your down payment amount and the lender you choose are key financial decisions. If you opt for a conventional mortgage (from a private lender), PMI may be required.
Lenders typically mandate PMI if your down payment is less than 20%. The purpose of PMI is to protect the lender in case you are unable to repay your loan. While PMI may help you secure a loan, it does add to the overall cost of the mortgage.
Note: PMI usually costs between $30 and $70 per month for every $100,000 you borrow.
Example of Private Mortgage Insurance (PMI)
Let’s consider the example of buying a $400,000 home with a 30-year mortgage at a 5% interest rate. According to Freddie Mac’s PMI calculator, here’s how the monthly PMI payment might differ based on the size of your down payment:
| Down Payment | Monthly PMI Payment |
|---|---|
| 5% | $365 |
| 10% | $234 |
| 15% | $95 |
| 20% | $0 |
How Long Will You Pay PMI?
Typically, PMI will be required until you’ve built 20% equity in your home. Home equity is the difference between your home’s current value and the remaining mortgage balance.
Once you reach 20% equity, your lender may automatically cancel PMI. However, you can request cancellation sooner if you make additional payments toward your mortgage balance to reach 20%.
If you’re refinancing, PMI might still be required if your loan-to-value (LTV) ratio exceeds 80%, as a higher LTV ratio is considered a greater risk to lenders.
Benefits of PMI
While PMI protects the lender, it doesn’t offer protection for the borrower. If you fail to make your mortgage payments, you could still face foreclosure. Additionally, you will still be responsible for homeowners insurance.
However, PMI has its benefits:
- It allows you to secure a mortgage even if you can’t afford a 20% down payment.
- PMI may improve your chances of qualifying for a loan.
Types of PMI
Different types of PMI have varying payment structures. Below are the five primary types:
- Borrower-Paid Mortgage Insurance (BPMI) This is the most common type of PMI. The borrower pays PMI as part of their monthly mortgage payment. These payments continue until the borrower reaches 20% equity in the home.
- Single-Premium Mortgage Insurance With single-premium PMI, the borrower makes a one-time upfront payment at closing. This eliminates the need for ongoing monthly payments, although the cost is higher initially.
- Lender-Paid Mortgage Insurance (LPMI) In this case, the lender covers the PMI costs, but borrowers typically face higher interest rates as a result. This type of PMI cannot be removed, even once 20% equity is reached.
- Split-Premium Mortgage Insurance This option combines elements of BPMI and single-premium PMI. The borrower makes an upfront payment at closing, as well as monthly payments, which are usually deducted from the escrow account. It provides flexibility by reducing the upfront costs and offering lower monthly payments.
- Federal Home Loan Mortgage Insurance Premium (MIP) This PMI type applies to loans backed by the Federal Housing Administration (FHA). FHA loans are easier to qualify for, as they allow lower down payments and credit score requirements. However, FHA loans come with an upfront fee of 1.75% of the loan amount and ongoing monthly premiums. These fees typically cannot be removed, but you can refinance your FHA loan into a conventional loan to potentially remove MIP.
The Bottom Line
PMI helps offset lender risk when borrowers make smaller down payments. It’s an added expense, but it allows individuals to buy a home sooner, even without 20% down.
Before deciding on a mortgage that requires PMI, consider the costs and how it will impact your total loan payments. Once you build 20% equity in your home, you’ll no longer need to pay PMI. However, if you have MIP from an FHA loan, it might remain for the life of the loan unless you refinance.
