Private Mortgage Insurance (PMI): How It Works and How to Avoid It

What Is Private Mortgage Insurance?

Private mortgage insurance (PMI) is a type of insurance that lenders require on conventional loans when the down payment is less than 20% of the home's purchase price. It protects the lender, not the borrower, by covering the lender's losses if you default on the loan.

PMI can be paid in several ways: a monthly premium added to your mortgage payment, an upfront premium paid at closing, or a combination of both. Some lenders also offer lender-paid PMI, where the lender pays the premium in exchange for a higher interest rate on your loan.

Sources: Consumer Financial Protection Bureau, Investopedia, Chase

When Is PMI Required?

PMI is required on conventional loans when your down payment is less than 20% of the purchase price. This is a standard rule across most lenders, as it reduces the lender's risk when you have less equity in the home.

The loan-to-value (LTV) ratio—the loan amount divided by the home's value—is key. If your LTV is above 80%, PMI is typically required. Once you reach 20% equity (80% LTV), you may be able to request PMI cancellation.

Sources: Consumer Financial Protection Bureau, Investopedia, Bankrate, Wells Fargo, Chase

How Much Does PMI Cost?

PMI costs vary depending on your loan amount, down payment, credit score, loan term, property type, and the type of PMI you choose. According to Freddie Mac, PMI typically costs between $30 and $70 per month for every $100,000 borrowed.

The Urban Institute reports that the average annual cost of PMI ranges from 0.46% to 1.5% of the original loan amount. Movement Mortgage gives a broader range of 0.2% to 2% annually. These ranges reflect different borrower profiles and market conditions.

Sources: Investopedia, Wells Fargo, Bankrate, Movement Mortgage

How PMI Is Calculated

PMI is calculated as a percentage of your loan amount, typically ranging from 0.2% to 2% annually. The exact rate depends on several factors: your loan amount, down payment, loan-to-value ratio, credit score, loan term, property type, and the PMI type.

For example, a larger down payment (lower LTV) and a higher credit score generally result in a lower PMI rate. Your lender will provide a specific quote based on your situation.

Sources: Movement Mortgage

How to Avoid PMI (Options and Strategies)

There are several ways to avoid PMI, each with trade-offs. The most straightforward is to make a 20% down payment, eliminating the need for PMI. However, this may not be feasible for many buyers.

You can also consider loan types that do not require PMI, such as VA loans. Another option is lender-paid PMI (LPMI), where the lender pays the insurance premium but charges a higher interest rate instead. This can lower your monthly payment but may increase total interest costs over the loan's life.

Other strategies include piggyback loans (a second mortgage to reach 20% equity) or asking the lender about alternatives. Each option has pros and cons, so compare them based on your financial situation.

• Make a 20% down payment.
• Use a loan type that does not require PMI, such as a VA loan.
• Opt for lender-paid PMI (LPMI) with a higher interest rate.
• Consider piggyback or 80-10-10 loans.
• Ask your lender about other PMI avoidance options.

Sources: Consumer Financial Protection Bureau, Investopedia, Movement Mortgage

How to Remove PMI from Your Mortgage

Once you reach 20% equity in your home, you can request PMI cancellation. You must be current on your mortgage payments and may need to provide documentation, such as a new appraisal, to verify your home's current value.

If your home's value has increased, you may be able to cancel PMI earlier, but lenders typically require a new appraisal to confirm the value. This can involve a fee, but it may be worth it if your home has appreciated significantly.

Lenders are required to automatically cancel PMI when the loan balance reaches 78% of the home's original value or when you reach the midpoint of the loan term, whichever comes first. This is a legal requirement under the Homeowners Protection Act, though the law is not always explicitly named in lender materials.

Sources: Bankrate, Wells Fargo, Movement Mortgage, Investopedia

PMI vs. Mortgage Insurance Premium (MIP) vs. Funding Fee

PMI is specific to conventional loans, while FHA loans require a Mortgage Insurance Premium (MIP). MIP includes an upfront premium of 1.75% of the base loan amount and an annual premium of 0.15% to 0.75%, depending on your loan terms.

FHA MIP typically lasts for the life of the loan if your down payment is less than 10%. If you put down 10% or more, you can have MIP removed after 11 years. This differs from PMI, which you can cancel once you reach 20% equity.

VA loans do not require PMI or MIP but have a one-time funding fee. The fee is set by the Department of Veterans Affairs and varies based on your service history and down payment. It can be rolled into the loan amount.

• PMI: conventional loans, cancelable at 20% equity.
• MIP: FHA loans, includes upfront and annual premiums.
• Funding fee: VA loans, one-time fee, no monthly insurance.

Sources: Investopedia, Wells Fargo, Ouachita Valley Federal Credit Union