Important Points to Remember:
- PMI is mandatory for conventional loans with less than a 20% down payment.
- It increases your monthly expenses but can be eliminated once you reach 20% equity.
- You can avoid PMI by making a larger down payment, opting for a VA loan, or using a piggyback loan.
If you’re in the market for a new home and considering a down payment of less than 20%, you’ve likely encountered the term PMI. Understanding PMI is crucial for making informed financial decisions, whether you’re looking at properties in Denver, CO or contemplating real estate in Tampa, FL.
In this comprehensive guide by Redfin, we’ll delve into all aspects of private mortgage insurance (PMI), including strategies to avoid it or remove it when the time is right.
Understanding Private Mortgage Insurance (PMI)
PMI, short for private mortgage insurance, is a type of insurance that safeguards your lender – not you – in case you default on your mortgage payments.
Lenders mandate PMI for conventional loans when your down payment falls below 20% of the home’s purchase price. While it facilitates home buying with a smaller initial investment, it adds to your monthly financial obligations.
Reasons for Lender Requirement of PMI
PMI mitigates the lender’s risk. With a down payment below 20%, you are perceived as a higher-risk borrower. PMI provides the lender with a financial cushion in case of loan default.
Varieties of Private Mortgage Insurance
Several types of PMI exist, and the most suitable one for you depends on your financial circumstances and lender protocols:
- Borrower-paid PMI (BPMI): This is the most prevalent type. You pay the premium as part of your monthly mortgage installment. It can be terminated once you attain 20% equity.
- Lender-paid PMI (LPMI): The lender covers the insurance cost, but typically charges a higher interest rate in return. This type cannot be canceled; eliminating it necessitates refinancing.
- Single-premium PMI: You pay the entire premium upfront at closing, either in cash or financed into your loan. While it reduces your monthly payment, it carries risk if you sell or refinance early.
- Split-premium PMI: A combination of upfront and monthly payments. You make part of the premium payment upfront and the remainder in monthly installments.
Understanding these distinctions can assist you in selecting the most cost-effective option based on your tenure in the home and financial plan.
Cost of Private Mortgage Insurance
The cost of PMI hinges on various factors, including your loan amount, credit score, and down payment. Here’s a general overview:
- Typical PMI cost: 0.3% to 1.5% of the original loan amount per year
- Example: On a $300,000 loan, PMI could amount to $75 to $375 per month
TIP: You may be able to lower PMI rates by enhancing your credit score or increasing your initial down payment.
Filip Telibasa, a certified financial planner and owner of Benzina Wealth, highlights that many homeowners are taken aback by refinance-related expenses such as prepaid taxes and insurance, escrow funding requirements, transfer taxes in specific states, and the fact that “no closing cost” refinances still entail costs within the loan structure. He suggests requesting a comprehensive Loan Estimate early in the process and comparing the total cash required to close rather than solely focusing on the monthly payment.
Payment Options for PMI
PMI can be paid through various methods, contingent on the loan and lender:
- Monthly premium (most common): Integrated into your monthly mortgage payment
- Upfront premium: Settled at closing
- Hybrid: A combination of upfront and monthly payments
Your lender will elucidate the available options during the loan application procedure.
When and How to Eliminate PMI
PMI is not permanent. You can eliminate it once you’ve accumulated sufficient equity in your home.
You can request PMI cancellation when:
- You’ve attained 20% equity in your home (based on the original purchase price)
- You possess a good payment record
- Your mortgage is up to date
PMI is automatically removed when:
- You achieve 22% equity in your home (provided you’re current on payments)
You can also refinance your mortgage if your home’s value has significantly appreciated, enabling you to eliminate PMI sooner.
Telibasa emphasizes that homeowners should assess refinancing beyond securing a lower interest rate. He suggests that the actual break-even point depends on your intended duration in the home, whether the reduced payment substantially enhances cash flow, and how you plan to utilize the monthly savings. For certain homeowners, investing the difference may yield greater long-term value than increasing discretionary expenditures.
Explore our guide: How Much Equity Do I Have in My Home? Here’s How to Calculate Home Equity
Methods to Avoid PMI Completely
Here are a few strategies to bypass PMI when purchasing a home:
- Provide at least a 20% down payment on a conventional loan
- Consider lender-paid PMI (LPMI): The lender covers the insurance cost but usually imposes a higher interest rate
- Opt for a piggyback loan: Secure a second loan to cover a portion of the down payment
- Explore VA loans (for eligible veterans and service members), which do not necessitate PMI
PMI vs. Other Mortgage Insurance Varieties
Not all loans utilize PMI. When researching mortgage insurance, it’s easy to conflate PMI with other similar-sounding terms. Here’s a brief comparison of the distinctions:
| Loan Type | Insurance Type | Required If… |
| Conventional | PMI | Down payment < 20% |
| FHA | MIP (Mortgage Insurance Premium) | Always required, irrespective of down payment |
| VA | No PMI | May necessitate a funding fee |
| USDA | Guarantee Fee | Similar to PMI, mandatory for all USDA loans |
Differentiating PMI, MIP, and MPI
- PMI (Private Mortgage Insurance): Compulsory for conventional loans when the down payment is below 20%. Protects the lender in case of default.
- MIP (Mortgage Insurance Premium): Mandatory for FHA loans. Unlike PMI, MIP is typically required for the entire loan term unless refinanced.
- MPI (Mortgage Protection Insurance): Elective insurance that covers your mortgage in case of disability, job loss, or death. This safeguards you or your family, not the lender.
Understanding these concepts aids in selecting the appropriate loan product and avoiding unnecessary confusion during the mortgage process.
Is PMI a Sound Investment?
PMI raises your monthly housing expenses, but it can be a beneficial trade-off if it accelerates your path to homeownership. This is particularly relevant in rapidly appreciating markets, where home prices may surge faster than your ability to save for a 20% down payment.
While not suitable for every buyer, if you are financially secure and intend to stay in your home long enough to amass equity, PMI can represent a short-term cost with long-term advantages.