PMI: A guide to private mortgage insurance

When you take out a home loan or refinancerefinance-hl000061 your mortgage, your lender may require you to pay for an additional type of insurance — private mortgage insurance (PMI). But what is PMI, why is it required and how is PMI calculated? Let’s take a closer look.

What is PMI?

PMI is a type of insurance that lenders require for conventional mortgages with a high loan-to-value (LTV) ratio. Lenders accept some level of risk with these mortgages, and PMI helps to lower that risk.

Although you (the borrower) pay for PMI, this insurance isn’t actually for you — it protects the lender. If you default on your mortgage, PMI helps to pay part of the remaining loan balance back to the lender. However, PMI does offer borrowers potential benefits too, such as helping you potentially qualify for a conventional loan that you might be otherwise ineligible for.

Types of PMI

There are various PMI options, each with its own payment structure and set of considerations. Here are three main types you might encounter:

• Borrower-paid PMI (BPMI): Another name for your standard mortgage insurance, BPMI is paid as part of your monthly mortgage payment until you reach 20% equity in your home.
• Lender-paid PMI (LPMI): With LPMI, your lender covers PMI costs. In exchange, you typically pay a higher interest rate on the mortgage itself.
• Single-premium PMI: This type of mortgage insurance involves paying a one-time, upfront premium at closing. You may also be able to roll the costs of single-premium PMI into the loan itself.

PMI vs. MPI vs. MIP

Private mortgage insurance is often confused with a few related terms — mortgage protection insurance (MPI) and mortgage insurance premium (MIP). PMI is specific to conventional loans with lower down payments, protecting the lender in case of borrower default. MPI is designed to protect the borrower and may cover mortgage payments in events like death, disability or job loss, depending on the policy terms. MIP, on the other hand, is tied to FHA loans and protects the lender in the event the borrower defaults on the FHA loan. MIP includes both a monthly premium and an up-front mortgage insurance premium (UFMIP), and it can be financed or paid at closing.

When is PMI required?

There are two common scenarios in which PMI is required.

• Your down payment is less than 20%: Most conventional lenders require a down payment of at least 20% of the purchase price. You can calculate your down payment percentage by dividing the amount you plan to put down by either the market value or the purchase price of the home (whichever is less). If you can't afford to put down at least 20%, you may have to pay for PMI.
• For refinance loans, your loan-to-value ratio is over 80%: If you're refinancing your current mortgage, most conventional lenders require an LTV ratio of 80% or less to avoid having to pay for PMI. You can calculate your LTV ratio by dividing your new mortgage amount by the market value of your home. If your LTV is over 80%, you may need PMI.

Do all loans require PMI?

Not all loans require PMI. PMI is generally required for conventional loans when the down payment is less than 20% or the loan-to-value (LTV) ratio is over 80%. However, certain types of government-backed loans, such as FHA and VA loans, have their own mortgage insurance requirements that do not use PMI.

How much is PMI?

PMI costs are generally a small percentage of your mortgage. How much you pay depends on several factors:

• Your total loan amount: PMI expenses are generally higher for larger mortgages, since they represent a percentage of your total mortgage.
• Your credit score: Lenders typically charge borrowers with higher credit scores lower PMI percentages, as these borrowers are seen to be lower-risk.
• LTV ratio: Higher LTV ratios can result in higher PMI costs since lenders typically prefer a ratio of 80% or lower.
• Down payment: Smaller down payments often lead to higher PMI rates since it’ll take longer for you to reach 20% equity.

Lenders typically maintain charts that show the PMI percentage to charge in various situations. You can ask your lender for a specific percentage to make your calculations easier.

How is PMI calculated?

To calculate your PMI, ask your lender for your PMI percentage or use the range listed below. Then follow these steps:

• Identify the property value: You can get the exact figure from a recent appraisal or use an estimate of how much you plan to offer for the house.
• Find the total loan amount: To estimate your PMI for a refinance, start with your current mortgage balance. For a new mortgage, subtract your down payment from the home price.
• Calculate the LTV: Divide the loan amount by the property value. Then multiply by 100 to get the percentage. If the result is 80% or lower, you likely don't have to pay PMI. If it's higher than 80%, move on to the next step.
• Estimate your annual PMI premium: Take the PMI percentage your lender provided and multiply it by the total loan amount. The result is your annual premium. To estimate your monthly premium, divide the result by 12.

For more accurate results, speak with a home lending advisor for more specific information and personalized guidance.

Who provides PMI?

As the buyer, you don't choose your PMI provider. Instead, lenders arrange PMI directly with their provider of choice, so you don't have to take any additional steps. PMI rates may vary among lenders and mortgage types.

If you have to pay PMI, your lender will set up the payment and coverage, connecting the PMI directly to your loan. That means you don't have to worry about remembering an extra payment or providing proof of PMI. Instead, your lender charges you for it automatically.

When do you pay PMI?

There are a few ways to handle PMI payments. Some lenders may let you choose a payment method. Others may require you to agree to a specific option. The most common PMI payment methods include:

• Monthly premium: Paying a monthly premium is one of the more common PMI options. In this case, your lender automatically adds PMI to your monthly mortgage payment. You won’t have to make a large upfront payment, but your monthly payments will be higher.
• Upfront premium: Rather than paying every month, you may have the option to pay the full cost at once. This is single-premium PMI. In this case, your lender arranges for you to pay PMI when you close on the loan. While it's an additional closing cost, your monthly mortgage payment will be lower.
• Monthly and upfront premiums: Alternatively, your PMI might come in a combination of the two methods above. In this case, your lender arranges for you to pay a portion of your PMI at closing and adds the rest to your monthly mortgage payments.

Can you reduce or eliminate PMI?

You can get rid of PMI once your LTV ratio drops below 80%. To stop paying PMI, request termination from your lender when your LTV reaches this threshold. Generally, lenders are required to automatically cancel PMI when your LTV hits 78%refinance-hl000061, but you may qualify for early termination if you meet certain criteria such as being current on payments and having a loan that qualifies. It’s generally recommended to be prepared to cover the cost of an appraisal to verify your home’s current market value. Ending PMI early may save you significant amounts on your mortgage.

How to avoid paying PMI

In some cases, you may be able to avoid paying PMI altogether. Some of the following guidelines might help you save on PMI costs. Ask your lender to help you do the math to find the most affordable option for you.

Make a down payment of 20% or more

When you're planning to buy a house, review your savings to calculate the maximum down payment you can afford. If you can put down at least 20% of the home price, you can avoid paying PMI. Some homebuyers may prioritize homes on which they can afford a 20% down payment.

Pay down your current mortgage balance

If you're planning to refinance your home but the current LTV is over 80%, consider paying off more of your mortgage balance first. If your mortgage servicer doesn't penalize you for prepayments, you can consider paying off more of your mortgage right away. Otherwise, you may have to wait until you've made a few more monthly payments.

Consider other loan options

Some lenders may offer alternative options even if your LTV is over 80%. Ask your lender if you qualify for other non-conventional loan options, such as FHA loans or VA loans.

PMI pros and cons

Private mortgage insurance has its own potential advantages, such as enabling borrowers to enter the homebuying market earlier, as well as some potential downsides, including the additional PMI costs. Let’s take a closer look at some pros and cons of PMI:

PMI pros

• Helps enable homebuying: PMI helps borrowers buy homes without a 20% down payment, a potentially significant financial hurdle for some homebuyers.
• Increased loan eligibility: By helping to mitigate risk, PMI can potentially help borrowers qualify for a conventional loan they may not otherwise be eligible for.

PMI cons

• Added monthly costs: PMI costs add to the monthly mortgage payment, increasing the overall cost of homeownership.
• Lender protection only: PMI protects the lender, not the borrower, in case of default.

In summary

What is PMI? Private mortgage insurance, or PMI, is insurance that helps mitigate the risk of lending to borrowers with higher LTV ratios. PMI may benefit borrowers by allowing them to potentially qualify for mortgages with lower down payments, though it adds an extra PMI cost to the monthly mortgage payment until they hit a certain equity mark. There are a few types of PMI, and the cost varies based on factors such as your loan amount, credit score, LTV ratio and total down payment. If you’re curious to learn more about PMI, whether it’s worth it for you and how to potentially avoid it, consider speaking with a qualified home lending advisor.

What is PMI FAQs

1. Is PMI tax deductible?

PMI’s tax deductibility can vary based on current tax laws. To determine if you can deduct PMI on your taxes, check the latest IRS guidelines or consult with a qualified tax professional. Eligibility may depend on factors such as your income and the date of your mortgage.

2. How long do you have to pay PMI?

You typically have to pay PMI until you reach 20% equity in your home, at which point you can typically request cancellation. Additionally, your lender may be required to cancel PMI once your mortgage balance reaches 78% of the original home value, or 22% equity. A home lending advisor can provide more tailored guidance.

3. Do FHA loans have PMI?

FHA loans require a form of mortgage insurance called a mortgage insurance premium (MIP). Borrowers generally pay an upfront MIP at closing and an annual MIP divided into monthly installments and included in the mortgage payments.

4. Should I pay off my PMI early?

Paying off PMI early may save you money over time. However, you cannot allocate funds directly to your PMI costs. To pay off PMI early, you would need to make extra payments towards your mortgage principal to reach 20% equity faster. Once you achieve 20% equity, you can request to have PMI removed, effectively lowering your monthly payments.

5. Is it worth it to pay PMI?

Whether PMI is worth it depends on your personal financial situation and financial goals. Paying PMI may be worth it if it allows you to buy a home sooner without waiting to save for a 20% down payment. While PMI increases your monthly payments, the ability to enter the housing market may provide an opportunity to benefit from home appreciation sooner. A qualified home lending advisor can provide more personalized guidance based on your unique financial circumstances.