What exactly is private mortgage insurance (PMI)?

10 Sep

One of the biggest obstacles to purchasing a new home is coming up with a sufficient down payment. The majority of mortgage lenders require a 20 percent down payment but that can be difficult in a market with high prices. As an example, if you are looking at homes in the $400,000 range you will need to bring $80,000 to the table and that can be hard to save for many of us. 

If a lender allows you to come in below the 20 percent down threshold, you will be required to carry PMI or private mortgage insurance. We put together this primer on PMI to help answer all of your questions about private mortgage insurance. 

What exactly is private mortgage insurance?

PMI is insurance for your mortgage, it ensures that your lender will be paid if you default on your loan. You pay a monthly premium, just like other insurance products and if you default on your mortgage, the lender is paid out of the policy. PMI insurance doesn’t protect you directly like other types of insurance, but it does allow you to become a homeowner even if you don’t have the required 20 percent down payment. 

PMI insurance does not prevent you from facing foreclosure if you fail to make your mortgage payments or from your credit score getting dinged if you fall behind on mortgage payments.

Your lender will require PMI to help cover the additional risk it is assuming when it funds your mortgage with a smaller down payment up front.

When it comes to mortgage insurance for federally guaranteed loans, PMI is a bit different than with a conventional loan. FHA loans and USDA loans operate a little differently for PMI. FHA loans require mortgage insurance and while the rates are lower, you cannot cancel the policy even after you pass the 20 percent threshold for equity in the house, basically you will pay for PMI insurance over the life of the loan.

A loan backed by the U.S. Department of Veterans Affairs or the U.S. Department of Agriculture do not require mortgage insurance. 

How much is PMI?

The price of PMI can vary dramatically but it tends to range between 0.55% to 2.25% of the original loan amount, according to Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute.

As an example, if you are looking for a $300,000 mortgage, your PMI costs would run between $1,650 to $6,750 per year which breaks down to $137.50 to $562.50 per month.

There are a number of factors that will determine the cost of PMI:

  • Size of your mortgage: The more money you borrow, the higher your PMI premium will be.
  • Down payment: The more money you put up for the down payment, the less you pay for PMI.
  • Credit score: Your lender will pull your credit report and if your score is lower, the more you will pay for PMI.
  • Type of mortgage: The type of mortgage you choose will impact the cost of PMI. An adjustable rate mortgage will be more expensive than a fixed rate mortgage as an adjustable rate is considered riskier.

In most cases, the cost of the PMI will be added to your monthly mortgage payment. However, some lenders do allow borrowers to pay the entire PMI premium in an upfront payment or a combination of an upfront payment and monthly premiums. 

FAQ’s for PMI

Here are some of the most common questions we get about PMI:

Is PMI tax deductible?

Currently, PMI is tax deductible but that may be coming to an end. Congress extended the tax deduction for mortgage insurance premiums, through the end of 2020 so unless they act again in the next few months, this deduction will eventually go away.

If your adjusted gross income is more than $100,000 or $50,000 if married but filing separately on Form 1040 or 1040-SR, line 8b, the deduction may be reduced or eliminated completely. Once your income exceeds $109,000, or $54,500 if married but filing separately, the deduction is eliminated. 

When can you stop paying PMI?

Once you have 20 percent equity in your home, you can usually get rid of PMI. There may be additional requirements, such as a good payment history and the absence of a second mortgage.

How do I avoid private mortgage insurance?

The best way to avoid PMI is to put at least 20 percent down. A 20 percent down payment is the best way to go if you have a conventional loan.

If you qualify, consider going with a government-insured loan. Loans backed by the U.S. Department of Veterans Affairs and the U.S. Department of Agriculture do not require mortgage insurance.

If you have to get PMI, always keep an eye on your loan balance as well as your current home value. Once you pass the 20 percent threshold, contact your lender and ask for PMI to be dropped.

Do all lenders require PMI?

The majority of lenders will require PMI for a conventional loan if you have less than 20 percent down. However, there are a few options that may allow you to get a loan without PMI:

There are low down-payment, PMI-free mortgages available but in most cases, you will pay a higher interest rate. As an example, PMI Advantage from Quicken Loans allows borrowers to get a mortgage with less than 20 percent down and no PMI but they do push up the interest rate. The best advice is to do the math and see which option makes the most sense for you. 

Bank of America also offers a loan called the Affordable Loan Solution. This product is designed for low-income borrowers and can require as little as 3 percent down and no PMI requirements. There are loan and income limits that apply to these loans.

VA loans don’t require PMI, if you can qualify for one.

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