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What Is PMI? A Consumer Guide To Private Mortgage Insurance

PMI is an abbreviation that stands for private mortgage insurance. Many homebuyers, especially those buying a home for the first time, are unfamiliar with the requirements for mortgage insurance, as well as what exactly it’s for. We’ve put together a handy guide to private mortgage insurance (PMI) to answer some of the questions that come up most often for consumers. 

So just what is private mortgage insurance?

Often referred to as PMI, private mortgage insurance is required by lenders for borrowers who get a mortgage but don’t have much equity in the home. This usually happens when buyers don’t have a large amount of cash for a down payment. Private mortgage insurance protects the lender in case you default on your home loan. It allows lenders to recover their investment, even if the property’s worth is not enough to pay off the loan balance.

How much of a down payment do I need to make so that I don’t have to buy PMI?

Usually a minimum of 20% down is what it takes to avoid paying the private mortgage insurance premium, but with the recent downturn of the economy, it can be difficult for first time homebuyers to come up with that amount.

However, PMI isn’t a bad thing. It allows lots of consumers to purchase a home with a small down payment, as low as 3%. It could take years of saving to get to a 20% down payment, but with PMI on a mortgage, you have the freedom to put less money down and get into the house you want earlier.

How much does private mortgage insurance cost?

PMI costs vary somewhat, but you can typically expect to pay around $40-$50 monthly per every $100,000 borrowed. For example, say you take out a $400,000 loan for your home. You might pay about $200 a month for PMI, or about $2,400 each year. This can add up fast, especially on longer term mortgages, where you’ll be paying over many years. If you have to purchase PMI, be sure to factor it into your home buying budget.

How long do I have to have PMI?

There are two ways to eliminate your private mortgage insurance. The first way is to pay down your mortgage until it equals either 80% of the original purchase price or appraised value of the property at the time the loan was acquired, whichever is less.

The second way is an automatic cancellation by your lender. However, a lender will not cancel your PMI payments until you have 22% equity in your home, instead of 20%. You do have the right to cancel your mortgage insurance at 20% yourself, but the lender will not do it automatically for another 2%. Easier, yes, but it will cost you more money. You’ll have to make the decision as to whether the effort is worth the expense.

Is there another way to avoid purchasing private mortgage insurance?

Yes, there are a couple of ways to get around PMI,  even if you don’t have the 20% to put down on a home.  Some lenders will exempt buyers from the mortgage insurance requirement if you accept a higher interest rate on your loan. The increased rates typically range from .75% to 1%, depending on the down payment amount. This route has an added benefit—interest is tax deductible, while private mortgage insurance is not.

The other avenue is called an  80-10-10 loan, which involves taking out two loans and putting 10% down on the loan. The 90% loan is then financed with a first mortgage equal to 80% of the sale price, and a second mortgage for the 10% of the remaining sale price. The second mortgage will have a higher interest rate, but because it only applies to 10% of the total loan, the payments for both mortgages will still be lower than paying one mortgage with PMI. And remember, the interest on the two mortgages is tax deductible.

Though private mortgage insurance can be expensive, it’s still a great way for consumers to be able to put down a small down payment, while allowing lenders the security to provide home loans to a wider demographic.

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