Learn the Basics of PMI, How It Helps with Homebuying and Ways Around It
Getting a Grip on Private Mortgage Insurance
Financing your home purchase with a conventional mortgage and less than 20 percent down? You'll need private mortgage insurance (PMI). This product benefits your lender more than you, though — it protects the lender's investment if you default on the loan. Usually, the smaller the down payment, the more the insurance will cost. This page is an insider's guide to private mortgage insurance.
How PMI Helps Consumers Afford More Expensive Homes
Mortgage insurance allows cash-strapped homebuyers to potentially qualify for a bigger mortgage — and therefore, buy a more expensive house — than they could get with just a down payment. Lenders usually base mortgage decisions on the 43 percent rule, meaning the borrower's total monthly living expenses cannot be more than 43 percent of gross monthly income. For example, a person making $100,000 annually should only have up to $43,000 in housing and living expenses. Dividing this amount by 12 gives a monthly expense of about $3,583.
Let's say the borrower has $20,000 in cash for a down payment:
To avoid paying for private mortgage insurance, a borrower with good credit might qualify for an $80,000 mortgage to buy a $100,000 house based on that $20,000 (20 percent) down payment.
With PMI, the borrower's down payment could be as low as 5 percent of the total value of the house. Based on the 43 percent rule, suddenly, that same $20,000 could be put toward a $300,000 to $400,000 house, depending on the borrower's gross monthly income.
Alternatives to Paying for Private Mortgage Insurance
The simplest way to sidestep PMI is to provide a down payment of at least 20 percent of the home's purchase price. However, if putting down 20 percent will deplete your savings, Freddie Mac says buying PMI is the better option.
Seller concessions are another possibility. A realtor could negotiate for the seller to contribute a fixed sum to the buyer toward closing costs and PMI. For a highly motivated seller, this could make the difference in whether the loan will close.
Shopping around can pay off, too. There are lenders that offer programs to help borrowers with small down payments possibly avoid PMI, including Bank of America's Affordable Loan Solution Mortgage. The product lets income-eligible borrowers make a down payment as low as 3 percent with no PMI. To qualify, borrowers' income cannot exceed the Department of Housing and Urban Development's median income where they live, and they must have at least a 660 credit score.
Below is a rundown of different options for avoiding private mortgage insurance.
Borrow a Government-Backed Loan
Consider a government-backed home loan, such as an FHA mortgage, that comes with government insurance known as a mortgage insurance premium (MIP) because they require much less than 20 percent down to close a loan.
The FHA mission includes holding down costs for borrowers, especially first-time homeowners, so MIP may be less expensive than usual. MIP rates are lower on FHA loans with a term less than 15 years.
You pay two different insurance premiums. The first is paid upfront at a rate of 1.75 percent of the loan amount and due when you receive the loan. The other is an annual fee, typically 0.85 percent of the borrowed amount, paid monthly.
Save for a Larger Down Payment
Avoid PMI all together by putting down at least 20 percent of the home's purchase price.
You save money by not paying for PMI for the next five to seven years on a 30-year mortgage.
Coming up with a higher down payment means less cash on hand for other living expenses, while cutting into savings.
Use the '80/10/10' or '80/15/5' Arrangement
Consider a piggy-back loan that closes the gap between the price of the home and your cash down payment.
With 80/10/10, 80 percent of the total property value is covered by the first loan, 10 percent is covered by the second, or piggy-back, loan and the final 10 percent is covered by the down payment. The 80/15/5 loan works the same way, except you would only make a 5 percent down payment.
The piggy-back mortgage usually comes with a higher interest rate and a variable term. You will also have to pay closing costs on both loans. Unlike PMI, which gets canceled once your loan value dips below 80 percent, piggy-back loans don't go away until they are paid off.
Ask the Lender to Waive PMI
The Consumer Financial Protection Bureau says lenders may sometimes waive PMI with a small down payment, although they'll charge a higher interest rate.
With a good-to-excellent credit history, you may persuade the lender to forego PMI by pointing to creditworthiness as proof the insurance is not necessary.
Borrowers in most cases will pay a higher interest rate on the mortgage. This may or may not be less expensive than paying for PMI and the lower interest rate that would come with an insured loan.
Ask the Lender for LPMI
In lender-paid mortgage insurance (LPMI), the lender pays your mortgage insurance premium upfront in a one-lump sum, which can lower monthly mortgage payments. However, your loan will typically carry a higher interest rate.
With a superior credit rating (a FICO score of 750 to 850 is considered excellent), you might negotiate a loan without PMI and enjoy lower payments.
You're still paying for PMI, since the lender is passing on these costs in the form of a higher interest rate. Also, LPMI remains in place for the duration of the loan. It can only be cancelled if the loan is paid off or refinanced.
How to Remove Private Mortgage Insurance
Homeowners who pay PMI will continue to bear this cost unless they take action by:
Refinancing the mortgage with the same or a different lender.
Paying for a home reappraisal that could eliminate or reduce the PMI amount they must pay.
Waiting until the balance on the mortgage drops to 78 percent to 80 percent of the home value. In the wait-it-out approach, lenders reason that by the time the balance is down to 80 percent of the property value, the borrower's stake in the house, at 20 percent, is sufficient incentive to stay current on mortgage payments to protect the borrower's own investment.
The U.S. Homeowners Protection Act gives you the right to request a PMI cancelation on the date when the principal balance on your mortgage falls to 80 percent of your home's original value. This date must be given to you in writing on a PMI disclosure form when receiving a mortgage, according to the CFPB. Your lender must cancel PMI when your loan balance drops to 78 percent of your home's original value, even if you don't request a PMI cancelation. The most important thing to remember is mortgage payments must be kept current to terminate PMI, no matter how much is left on the balance.
Quick-Hit Insider Advice from a PMI Expert
Michael Zimmerman is head of investor relations for MGIC Investment Corp., which underwrites private mortgage insurance to lenders in the U.S. Zimmerman was promoted to lead investor relations in 2003. He joined MGIC in 1995 as vice president of mortgage banking strategies.
Is it possible for consumers to shop around for PMI?
"Typically, a borrower relies on the loan officer for the direction. There really isn't a consumer option for 'shopping around,'" Zimmerman explains. "The borrower usually isn't choosing, but if they're aware of a provider they can certainly suggest one." Zimmerman says lenders typically work with two to three PMI carriers to get the best rate available.
How can consumers minimize monthly PMI costs either before closing or until they reach the balance threshold to cancel PMI?
"There are ways for a borrower to minimize a monthly payment with different premium plans. There's the automatic cancellation, of course, and each PMI company offers a variety of different premium plans. There can be a monthly or annual payment plan or some split of those two, or it can be all upfront."
Is PMI a better value than the FHA's MIP coverage?
"Yes. With FHA, they add insurance to the loan amount and the borrower doesn't build equity as fast as with PMI," Zimmerman says, explaining that PMI is a separate item, meaning more of the borrower's payment goes toward the principal on the loan and builds equity faster. "Typically, after two years, Freddie and Fannie will call for a new appraisal and reevaluate the insurance." If the home's value increases to the point the borrower has 20 percent equity, they will reevaluate it as well, he says.
What is Private Mortgage Insurance?
The Consumer Financial Protection Bureau explains types of PMI, why it's required and why the borrower must pay the cost.
Down Payments and PMI
Freddie Mac's explainer on private mortgage insurance and down payment sizes.
Tips on Removing PMI
Information on when and how to get rid of PMI on a loan.
FHA Mortgage Insurance
FHA lenders require mortgage insurance when a borrower makes a down payment that's less than 20 percent of a home's purchase price or appraised value. This page explains the basics.
Glossary of Mortgage Terms
Explanations of common mortgage terms to help you prepare when meeting a lender or mortgage broker.
New to the mortgage process? This MoneyGeek guide to first-time homebuying takes a comprehensive look at the documents you'll need to process a loan, set a budget, choose the right lender and loan, and much more.
Learn About Conventional Mortgages
This MoneyGeek page provides a complete rundown on this most basic type of mortgage loan.
Federal Trade Commission
Home and mortgage advice from the FTC.
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