PMI: A Guide To Private Mortgage Insurance

If you make a down payment of less than 20% when you buy a home, your lender will probably require that you pay private mortgage insurance. Here’s what PMI is, how it works, and what it means for you.

PMI is a type of mortgage insurance that protects your lender if you stop making payments on your loan.

Mortgage insurance is often confused with homeowners insurance. However, they serve different purposes:

• Homeowners insurance protects you in case your property is damaged.

• Mortgage insurance protects the lender from the borrower not paying back the mortgage.

If you put down less than 20% when you buy a home, PMI will likely become a part of your regular mortgage payment. For example, if you buy a home for $200,000, you’ll likely need a down payment of $40,000 to avoid paying PMI.

After you’ve bought the home, you can typically request to stop paying PMI once you’ve reached 20% equity in your home. PMI is often cancelled automatically once you’ve reached 22% equity.  

Finally, PMI only applies to conventional loans – other types of loans often include their own types of mortgage insurance. For example, FHA loans require mortgage insurance premiums, which operate differently from PMI.

PMI, like other types of insurance, is based on insurance rates that can change daily. PMI typically costs 0.5% – 1% of your loan amount per year.

Let’s take a second and put those numbers in perspective. If you buy a $300,000 home, you would be paying anywhere between $1,500 – $3,000 per year in mortgage insurance. This cost is broken into monthly installments to make it more affordable. In this example, you’re looking at paying from $125 – $250 per month.

Your lender will also consider a few other factors when determining how much PMI you’ll have to pay as part of your regular mortgage payment. Let’s review some of them.

Down Payment Amount

Your down payment plays a significant role in determining how much PMI you’ll have to pay. A smaller down payment can represent higher risk for the lender, meaning the lender stands to lose a larger investment if you default and your home goes into foreclosure.

A lower down payment also usually means your regular mortgage payments are higher, and that it will take longer before you’re able to cancel PMI. All of this increases the possibility that you might miss a payment, meaning you may be charged higher PMI premiums.

Even if you can’t afford a down payment of 20%, increasing your down payment can reduce the amount of PMI you’ll have to pay.

Credit History

Your lender will review your credit history to see if you’ve been a responsible borrower in the past.

Your credit score can indicate how reliably you’ve paid back money you’ve borrowed. A higher credit score, for example, can show that:

• You regularly pay more than the minimum payments on your accounts and credit cards.

• You don’t borrow more money than you can pay back.

• You pay your bills on time.

• You avoid maxing out your credit limit.

A solid credit history and high credit score can mean a lender may charge less in PMI premiums because you’ve shown you’re a responsible borrower who pays back what you borrow.

On the other hand, if you have a lower credit score, your lender may have less faith in your ability to manage your debt responsibly. As a result, you may have to pay higher PMI premiums.

Type Of Loan

Your loan type can influence how much you’ll have to pay in PMI. For example, fixed rate loans can reduce the amount of risk involved with the loan because the rate won’t change, leading to consistent mortgage payments. Less risk can mean a lower mortgage insurance rate, meaning you might not need to pay as much PMI.

Adjustable rate mortgages, or loans with a rate that can go up or down based on the market, can bring more risk because it is harder to predict what your mortgage payment will be in the future. This means the mortgage insurance rate could be higher with ARMs. However, because ARMs also typically have lower initial interest rates than fixed rate mortgages, you may be able to pay more towards your principal, build equity faster and reduce the amount of PMI you need to pay.

In the end, there are a lot of elements that can influence how much PMI you’ll have to pay. Your lender can walk you through different loan options and how much PMI you should expect to pay.

How you can avoid PMI depends on what type you have:

• Borrower-paid private mortgage insurance, which you’ll pay as part of your mortgage payment

• Lender-paid private mortgage insurance, which your lender will pay upfront when you close, and you’ll pay back by accepting a higher interest rate

Let’s review how each type works in more detail, and what steps you can take to avoid paying either one.

How To Avoid Borrower-Paid PMI

Borrower-paid PMI is the most common type of PMI. BPMI adds an insurance premium to your regular mortgage payment.

You can avoid BPMI altogether with a down payment of at least 20%, or you can request to remove it when you reach 20% equity in your home. Once you reach 22%, BPMI is often removed automatically.

While it’s possible to avoid PMI by taking out a different type of loan, USDA and FHA loans have their own mortgage insurance equivalent in the form of mortgage insurance premiums and guarantee fees, respectively. Additionally, these fees are typically around for the life of the loan.

The lone exception involves FHA loans with a down payment or equity amount of 10% or more, in which case you would pay MIP for 11 years. Otherwise, these premiums are around until you pay off the house, sell it or refinance.

The only loan without mortgage insurance is the VA loan. Instead of mortgage insurance, VA loans have a one-time funding fee that’s either paid at closing or built into the loan amount.

The size of the funding fee varies according to the amount of your down payment or equity, your status when you served (i.e. regular military versus reserves or National Guard) and whether it’s a first-time or subsequent use. The funding fee can be anywhere between 1.25% – 3.3% of the loan amount. On a VA Streamline, also known as an Interest Rate Reduction Refinance Loan, the funding fee is always 0.5%.

It’s important to note that you don’t have to pay this funding fee if you receive VA disability or are a qualified surviving spouse of someone who was killed in action or passed as a result of a service-connected disability.

One other option people look at to avoid the PMI associated with a conventional loan is a piggyback loan. Here’s how this works: You make a down payment of around 10% or more and a second mortgage, often in the form of a home equity line of credit, is taken out to cover the additional amount needed to get you to 20% equity on your primary loan. (Quicken Loans^®doesn’t offer HELOCs at this time.)

Although a HELOC can help avoid the need for PMI, you’re still making payments on a second mortgage. Not only will you have two payments, but the rate on the second mortgage will be higher because your primary mortgage gets paid first if you default. Given that, it’s important to do the math and compare whether you’re saving money or if it just makes sense to make the PMI payments.

How To Avoid Lender-Paid PMI

Another option is for your lender to pay your mortgage insurance premiums as a lump sum when you close the loan. In exchange, you’ll accept a higher interest rate. You may also have the option to pay your entire PMI yourself at closing, which would not require a higher interest rate.

Depending on the mortgage insurance rates at the time, this may be cheaper than BPMI, but keep in mind that it’s impossible to “cancel” LPMI because your payments are made as a lump sum upfront. If you want to lower your mortgage payments, you’d have to refinance to a lower interest rate, instead of removing mortgage insurance.

There’s no way to avoid paying for LPMI in some way if you have less than a 20% down payment. You can go with BPMI to avoid the higher rate, but you still end up paying it on a monthly basis until you reach at least 20% equity. In that case, you’re back to the original amount from the BPMI scenario.

If you opt for BPMI when you close your loan, you can write to your lender in order to avoid paying it once you reach 20% equity. We’re aware that the idea of writing a letter is absolutely antiquated, but the process was enshrined in federal law by Congress in the Homeowners Protection Act of 1998.

Your letter should be sent to your mortgage servicer and include the reason you believe you’re eligible for cancellation. Reasons for cancellation include the following:

• Reaching 20% equity in your home (regardless of whether you made extra payments toward your principal in order to get there faster).

• Based on significant improvements to your home: If you’ve made home improvements that substantially increase the value of your home, you can have mortgage insurance removed. If your loan is owned by Fannie Mae, you must have 25% equity or more. The Freddie Mac requirement is still 20%.

• Based on increases in your home value not related to home improvements: If you’re requesting removal of your mortgage insurance based on natural increases in your property value due to market conditions, Fannie Mae and Freddie Mac require you to have 25% equity if the request is made 2 – 5 years after you close on your loan. After 5 years, you only have to have 20% equity. In any case, you’ll be paying for BPMI for at least 2 years.

For your request to cancel mortgage insurance to be honored, you have to be current on your mortgage payments and an appraisal has to be done to verify property value.

If you don’t request the mortgage insurance cancellation on a 1-unit primary property or second home, PMI is automatically canceled when you reach 22% equity based on the original loan amortization schedule, assuming you’re current on your loan.

If you have a multi-unit primary property or investment property, things work a little bit differently.

Fannie Mae lets you request cancellation of your PMI once you reach 30% equity, while Freddie Mac requires 35% equity.

Freddie Mac doesn’t auto cancel mortgage insurance on multi-unit residences or investment properties. Fannie Mae mortgage insurance cancels halfway through the loan term if you do nothing.

It’s very important that you cancel your mortgage insurance as soon as you can because the savings are significant. Let’s take our previous example of a $300,000 loan amount and assume this is a 1-unit primary property. Recall that you can request mortgage insurance termination when you reach 20% equity and it auto cancels at 22% equity.

On a 30-year fixed loan there are nine payments between the time you cross the 20% threshold and when the payments would auto cancel after breaking through the 22% barrier. If you had a mortgage insurance rate that was 0.5% of your loan amount, your savings would be $1,125. If you had a 1% mortgage insurance rate, you would save $2,250 in mortgage insurance payments over those 9 months.

It’s important to remember that since LPMI involves taking a slightly higher rate for the life of the loan (as compared to a rate without LPMI), it can’t be canceled. Depending on the market conditions when you reach 20% equity, you may or may not be able to get a lower rate by refinancing.

Your specific PMI rate, how long you’ll have to pay, and whether BPMI or LPMI is better for you depends on your individual loan and your unique financial situation. When you’re shopping for a home, ask your lender how they handle mortgage insurance and how much you could expect to pay in PMI – or another type of mortgage insurance. Rocket Mortgage^® by Quicken Loans^® is here to help you figure out your best options.