Private mortgage insurance is a way for homebuyers who can’t come up with a full down payment to still qualify to purchase a home. If you’re looking to buy a home and find yourself in this situation, it can be easy to overlook the financial ramifications of PMI and get caught up in the excitement of buying a home. Although PMI can help you get the home of your dreams, it does come with added costs and restrictions. Make an educated decision before you buy a home and learn what you need to know about mortgage insurance.
What Is PMI?
PMI is private mortgage insurance that’s used with conventional loans. Insurance companies provide PMI, which is arranged by your lender to protect them if the borrower stops making payments. But this only applies to mortgages in which the down payment was less than 20 percent of a home’s purchase price. It’s also used when a lender refinances a mortgage in which the borrower has less than 20 percent home equity.
What to Know About Private Mortgage Insurance
Learning about PMI prior to making an offer on a house or refinancing your mortgage can help you make the best decision for your financial situation. Here’s everything that a prospective homebuyer needs to know about PMI.
1. How to Avoid PMI
The best way to deal with PMI is to avoid it altogether by putting down the requisite 20 percent. In real-estate terms, this requires having a loan-to-value ratio of 80-20 or less, meaning you are borrowing 80 percent of the value of your home. If you don’t have the cash yourself, you can wait and save up, or find the money from another source.
Some lenders will offer loans with less than 20 percent down in exchange for a higher interest rate. Other types of loans, such as FHA, don’t require PMI but might have other costs.
2. PMI Protects Your Lender, Not You
Though you pay for it and it increases the cost of your loan, PMI does not protect you — it protects the lender. If you default on your mortgage payments, you could face foreclosure that could negatively impact your credit, whether you have PMI or not.
3. Different Types of Mortgage Insurance Programs Are Available
A variety of mortgage insurance programs help borrowers with low down payments or home equity to get home loans. Common mortgage insurance programs include:
- Private mortgage insurance for conventional loans arranged with a private mortgage insurance company: PMI rates are often lower than other mortgage insurance rates.
- Federal Housing Administration loans, which require FHA mortgage insurance: Premiums are the same for all borrowers, regardless of your credit score. FHA mortgage insurance has both an upfront cost and a monthly cost.
- U.S. Department of Agriculture mortgage insurance, which is similar to FHA loan insurance but cheaper
- Department of Veterans Affairs loan, which comes with a guarantee that replaces mortgage insurance on low down-payment mortgages
4. PMI Costs Vary by Credit Score and Down Payment Amount
So how much is PMI? It depends. Borrowers should expect their PMI to cost between 0.3 percent and 1.15 percent of a home loan amount, according to Realtor.com. The actual figure depends on your credit score and your total down payment amount. You can estimate your PMI cost using an online PMI calculator to get a better idea of how much you will pay.
5. PMI Premiums Could Be Due Upfront
PMI costs are known as premiums, and there are several ways to pay for premiums. Monthly premiums are added to your monthly mortgage payment, but upfront premiums get paid at closing. If you move or refinance, however, you might not receive a mortgage insurance premium refund.
Some lenders offer PMI with both a monthly and upfront premium component. You might even be able to roll your PMI premium in with your mortgage. Some insurance companies give borrowers a choice as to how to pay, so ask your lender if this is an option.
6. PMI Is Not the Same as Mortgage Life Insurance
Do not confuse PMI with mortgage life insurance, which pays your mortgage off if you die. Remember, PMI protects the lender, whereas mortgage insurance — sometimes called mortgage protection insurance — is a way for you to protect your heirs in case you die before your mortgage is paid off. PMI allows you to buy a home with a smaller-than-usual down payment, whereas mortgage insurance ensures that your mortgage debt will be paid off if you die.
7. You Can Get Rid of PMI
If you’re saddled with PMI payments, you might want to know how to get rid of PMI. Lenders should automatically terminate the mortgage insurance when your loan balance reaches 78 percent of the original home value. Once the balance reaches 80 percent — and as long as your payments are up-to-date — you can send your lender a written request to cancel your PMI. To refinance to get rid of PMI, your new loan needs a loan to value of less than 80 percent, which is effectively the same as a 20 percent down payment on a new loan.
8. PMI Might Be Tax-Deductible
The tax-deductibility of PMI is something of a gray area. Previously, PMI was deductible on mortgages that were taken out on or after Jan. 1, 2007. The deduction was reduced by 10 percent for every $1,000 a taxpayer’s adjusted gross income exceeded $100,000, vanishing completely for AGIs over $109,000. That tax break expired at the end of 2016, though. Congress could enact legislation to renew the deductibility of PMI at any time, so talk to your tax advisor for the most up-to-date status of the answer to the question, “Is PMI deductible?”
9. Some Homebuyers Want PMI
Is PMI worth it? For some homebuyers, the answer is “yes.” PMI might seem like a strange thing to want, because it increases the cost of a mortgage. PMI also allows homeowners to buy homes if they can afford the monthly payments but do not have enough cash for a 20 percent down payment.
Only you can decide whether the additional cost of PMI makes financial sense when you buy a home. Doing your research and asking lenders questions about PMI can help you make a more informed decision. Remember not to reach for a home you can’t afford just because PMI allows you to buy it.