9 min read May 09, 2024

What is PMI: Essential Insights for Mortgage Borrowers

PMI stands for Private Mortgage Insurance. Mortgage borrowers must pay PMI for loans with less than 20% downpayment. It eases the lender’s concerns about defaults and gives homeowners a chance to buy now rather than later!

Considering the median home price in the U.S. as $440,300, a 20% downpayment will cost you $88,060. Depending on your monthly income and saving habits, it may take you around 4-5 years or more to have a sufficient deposit to buy your house.

With PMI, you can buy your dream home and start building equity immediately.

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Key Takeaways

  • PMI Meaning: PMI (Private Mortgage Insurance) is an insurance that protects lenders when homeowners have a small down payment. It allows people to buy a home with less money saved but adds an extra cost to their monthly mortgage payments.
  • PMI Rate: Average PMI rate is around 0.1% – 2% of your mortgage per year. However, insurance rates can change daily, which will cause changes in the PMI amount.
  • Should You Consider PMI: Consider PMI if you are planning to buy a home with a down payment of less than 20% of the purchase price. It provides an opportunity to become a homeowner sooner, especially for those who may find it challenging to save a large down payment.

What is PMI in Real Estate?

When you get a mortgage loan with less than a 20% down payment, the lender considers it riskier because you have less equity in the property. The lender may ask you to pay for private mortgage insurance.

Private mortgage insurance means you pay an extra amount each month on top of your mortgage payment. The cost of PMI varies based on factors like your loan amount, down payment, and creditworthiness.

You usually make these premium payments until you have enough equity in the property, which is when the loan-to-value ratio is 80% or less.

How Much Does PMI Cost?

PMI costs around 0.1% – 2% of your mortgage per year. However, insurance rates can change daily which will cause changes in the PMI amount. A better way to calculate PMI is to understand your equity.

For example, if your home is valued at $200,000, a 20% downpayment amounts to $40,000. This means you have 20% equity in your property upfront. However, if you do not pay the downpayment, the PMI will be active until your reach 22% equity.

You may request your lender to stop PMI once you reach 20% equity.

How Much Does PMI Add to Mortgage?

The amount that Private Mortgage Insurance (PMI) adds to your mortgage can vary depending on several factors, including the loan amount, the PMI rate, and the loan term. You can expect to pay anywhere between $30 – $70 per month for every $100,000 borrowed.

How to Calculate PMI?

You can use an online mortgage insurance calculator to find out how much extra you must pay on top of your monthly mortgage payments. The average downpayment in America is 6%. But you can ask for a lower downpayment if you have a credit score above 620.

Check out the table below to see the approximate values. Calculations based on a 6% interest rate, 6% downpayment, and credit score between 620 – 639.

HomepriceDownpaymentPMI per monthTotal PMIHow Long you pay
$200,000$12,000$310$43,22811.62 years
$350,000$21,000$542$75,69611.63 years
$500,000$30,000$775$108,00711.61 years
$750,000$45,000$1,162$162,01611.61 years

PMI Formula

The PMI formula is used in the context of mortgage lending rather than insurance. It is used to calculate the monthly premium that borrowers need to pay for private mortgage insurance.

The specific formula and calculations may vary depending on the lender and the insurance provider. However, the general formula to calculate the monthly PMI premium is as follows:

PMI = (Loan amount x PMI rate) / 12

Types of Private Mortgage Insurance

There are two main types of Private Mortgage Insurance (PMI):

Borrower-Paid PMI: With borrower-paid PMI, the borrower will pay the mortgage insurance. This is the most common type. The cost of the insurance gets added to your monthly mortgage payment until the PMI is canceled or you finish paying off the loan.

The exact amount depends on factors like the loan amount, down payment, and credit score.

Lender-Paid PMI: With lender-paid PMI, the lender pays for the mortgage insurance on your behalf. The lender usually charges a slightly higher interest rate on the loan to cover the cost of the insurance. The higher interest rate helps the lender reduce the risk of providing mortgage insurance.

Lender-paid PMI may result in a lower monthly payment for you. However, it typically remains in effect for the entire loan duration and cannot be canceled.

» Can I Buy a House with Bad Credit?

Mortgage Insurance Vs. Homeowners Insurance

Home Mortgage Insurance and Homeowners Insurance serve different purposes for homeownership. Here’s a comparison between the two:

Mortgage Insurance

  • Purpose: Mortgage insurance ensures that the lender is protected if the borrower defaults on the mortgage loan.
  • Requirement: Lenders typically require mortgage insurance when borrowers make a down payment of less than 20% on a conventional mortgage.
  • Coverage: Mortgage insurance does not directly cover or protect the homeowner or their property.
  • Cost: Borrowers are responsible for paying the cost of mortgage insurance, either as a separate monthly premium or included in the mortgage payment.
  • Duration: Property Mortgage insurance is usually necessary until the borrower achieves a certain loan-to-value (LTV) ratio or builds enough equity in the property.

Homeowners Insurance

  • Purpose: Homeowners’ insurance safeguards the homeowner against losses or damages to their property and possessions.
  • Requirement: Although it is not mandatory, it is best to get homeowners insurance for a secure future.
  • Coverage: Homeowners’ insurance protects against various risks, such as fire, theft, vandalism, natural disasters, and personal liability.
  • Cost: The cost of homeowners insurance depends on factors like property location, size, value, and coverage options selected by the homeowner.
  • Duration: You pay insurance premiums till the time your homeownership lasts.

» Learn more here: What is VA Loan and Are You Eligible?

Factors that Influence the Cost of PMI

Several factors influence the cost of private mortgage insurance. Consider these factors to determine if you should buy your home without a downpayment.

  • Loan-to-Value (LTV) Ratio: The LTV ratio is the ratio of the loan amount to the appraised value of the property. A higher LTV ratio, indicating a smaller down payment, often leads to a higher mortgage insurance premium.
  • Down Payment: The size of the down payment made by the borrower directly impacts the cost of PMI. A larger down payment reduces the loan amount and can result in a lower premium.
  • Credit Score: Borrowers with higher credit scores generally qualify for better mortgage insurance rates. A good credit score reflects lower risk and can result in lower premiums. On the other hand, a lower credit score may lead to higher PMI costs.
  • Loan Term: The length of the loan term, such as 15 years or 30 years, can influence the cost of PMI. Longer loan terms may have higher mortgage insurance premiums compared to shorter-term loans.
  • Property Type: Different property types, such as primary residences, second homes, or investment properties, may have varying mortgage insurance rates.
  • Insurance Provider: The specific insurance provider or mortgage insurer chosen by the lender can affect the cost of mortgage insurance. Different insurers may offer varying premium rates and use different factors to calculate the mortgage insurance cost.

How to Avoid PMI?

You already know that you can avoid mortgage insurance by paying a 20% downpayment on your home loan. However, it may not be possible or feasible for all homebuyers to cough up a huge lumpsum amount at the time of buying.

Here are a few ways to avoid paying mortgage insurance when you buy a house.

👉 Learn How to Remove PMI

Piggyback loans

Consider obtaining a piggyback loan instead of a single large mortgage loan. With this approach, you take out two loans – a primary mortgage covering 80% of the home’s value and a secondary loan covering the remaining amount.

By structuring your financing in this manner, you can avoid the need for private mortgage insurance since your primary loan amount remains at or below 80% of the home’s value.

Improve your credit score

A high credit score is very attractive to lenders. If you have a score of above 620 you can easily convince your lender for reduced or no PMI requirements.

» Learn more here: 8 Proven Strategies to Quickly Repair Your Credit Score

Check out loans without PMI

Take the time to research loan programs that do not require mortgage insurance, such as government-backed loans like VA (Veterans Affairs) or USDA (United States Department of Agriculture) loans.

These loans often have specific eligibility criteria, so it’s important to determine if you meet the requirements and understand the associated terms.

» USDA Loans – A Path to Affordable Rural Homeownership

How to Get Rid of PMI?

If you already have PMI, you can take the following steps to get rid of it.

Check your LTV ratio

PMI is generally required until you have at least 20% equity in your home, which means your loan-to-value (LTV) ratio reaches 80% or lower. Ask your lender for a new appraisal to check your LTV. If it’s 80% or lower you can qualify to get home mortgage insurance removed.

Make Extra Mortgage Payments

You can make extra payments towards your mortgage principal to reach 20% equity sooner. Consider this option if you are close to the 80% LTV ratio.

» What is Curtailment on a Mortgage: All You Need to Know About Mortgage Curtailment.

Consider Refinance Options

Refinancing a mortgage involves replacing your current home loan with a new one that has better terms, such as a lower interest rate or a shorter loan term.

If the value of your home has significantly risen or if interest rates have dropped since you obtained your loan, refinancing can help you achieve a lower LTV ratio.

» Learn More Here: Refinance Mortgage Requirements

Bottom Line

If you’re considering purchasing a home but don’t have a large down payment saved up, PMI (Private Mortgage Insurance) can help you achieve your goal. PMI provides a solution by allowing you to secure a mortgage with a smaller down payment.

However, it’s essential to carefully consider the costs and long-term implications of PMI. Use an online mortgage insurance calculator to check how much extra you need to pay per month. Talk to your lender before making a final decision.

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Frequently Asked Questions

1. How much is private mortgage insurance a month?

Mortgage insurance typically costs 0.1% - 2% of your loan amount. So, if your home is priced at $300,000 you can expect to pay around $1,500 - $3,000 PMI per year. This is broken down into smaller payments of $125 - $250 per month.

2. What is PMI on a mortgage?

PMI on a mortgage is insurance that lenders require when borrowers have a down payment of less than 20%, protecting the lender in case of default and added to the monthly mortgage payment.

3. How long do you have to pay mortgage insurance?

The duration of mortgage insurance payments varies. For conventional loans, it can be temporary or permanent based on loan-to-value ratio, while FHA loans generally require mortgage insurance for the entire term or a minimum of 11 years.

4. How does mortgage insurance work?

The borrower pays a premium for the insurance, either as a lump sum at closing or as part of the monthly mortgage payments. If the borrower defaults, the insurance helps compensate the lender for the financial loss.

5. Do you pay PMI on a conventional loan?

Yes. You must pay conventional loan PMI if you have less than 20% down payment.

6. Does PMI go down each month?

No. PMI does not go down per month. You must pay PMI until you reach 20% equity in your home.

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