Private Mortgage Insurance (PMI): What is it and how is it calculated?

When you take out a home loan or refinance your mortgage, your lender may require you to pay for an additional type of insurance – private mortgage insurance.

When do you have to pay private mortgage insurance (PMI) and how much will it cost you? It depends on your loan-to-value (LTV) ratio. Find out when you have to pay PMI and learn how to calculate the cost.

What is PMI?

PMI is a type of insurance that lenders require for certain mortgages with high LTV ratios. Lenders always accept some level of risk with mortgages. However, PMI can help lower the risk that some mortgages bring.

Although you pay for PMI as the borrower, this insurance doesn't protect you. Instead, it protects the lender. If you default on your mortgage, PMI pays part of the remaining balance of the loan to the lender.

However, PMI does offer some benefits to you as the borrower. Paying PMI may help qualify you for a conventional loan that you wouldn't be eligible for under other circumstances.

When is PMI required?

You may have to pay for PMI if you're purchasing a house or refinancing your mortgage. Lenders may require PMI on certain loans if:

• 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 the lesser of the market value or purchase price of the home. If you can't afford to put down at least 20% on a purchase, 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.

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 require you to agree to a specific option. The most common PMI payment methods include:

• Monthly premium: Paying a monthly premium is the most common PMI option. 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. 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.

How much is PMI?

On average, PMI costs range between 0.22% to 2.25% of your mortgage. How much you pay depends on two main factors:

• Your total loan amount: As a general rule, PMI expenses are higher for larger mortgages.
• Your credit score: Lenders typically charge borrowers with high credit scores lower PMI percentages.

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 estimate it by using the amount 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, your PMI is 0%, which means you 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. If you don't know your PMI percentage, calculate for the high and low ends of the standard range. Use 0.22% to figure out the low end and use 2.25% to calculate the high end of the range. The result is your annual premium. To estimate your monthly premium, divide the result by 12.

Can you reduce or eliminate PMI?

If you're concerned about this extra expense, you'll be relieved to know that PMI usually ends before your loan does since lenders only require you to pay PMI while your LTV is above 80%. Once your LTV is below 80%, you can request to stop paying PMI.

To determine when your loan will reach the point where you no longer need PMI, lenders use an amortization schedule. If you opted to pay PMI at closing, your lender already used this schedule to calculate your total PMI amount. In most cases, you can't reduce or get a refund for part of your upfront premium.

If you pay a monthly premium, you may be able to eliminate PMI a little early since lenders end PMI automatically when you're scheduled to reach the 78% LTV point. You may qualify for early PMI termination if you meet the following criteria:

• Your LTV is 80% or lower
• Your loan started on or after July 29, 1999, when the Homeowners Protection Act (PDF) began
• You're current on your mortgage payments

Call your lender to cancel PMI early (PDF) if you meet these qualifications. Typically, your lender will request a broker price opinion (BPO) to confirm the current market value of your home. Your lender needs this data to calculate your current LTV. If the value of your home has decreased significantly, your LTV may have increased, which could disqualify you for early PMI termination.

As the borrower, you generally have to pay for the BPO or appraisal, which could cost a few hundred dollars. Depending on your monthly premium, however, ending PMI early could save you hundreds or thousands of dollars.

How to avoid paying PMI

In many cases, you can avoid paying PMI altogether. Some of the following strategies could 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. To get to the 20% mark, you may need to save a little more or rethink the house you want to buy.

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.

Get a higher-interest loan

Some lenders may offer alternative options even if your LTV is over 80%. Ask your lender about higher-interest loans, which may help them manage risk without charging PMI. If you aren't sure whether a higher-interest loan is worth saving on PMI costs, ask your lender for a direct comparison.