Saving enough money for a sizeable down payment may be stopping many Americans from getting onto the property ladder. But private mortgage insurance (PMI) may help you secure a loan you wouldn’t conventionally qualify for.
A cost on top of your mortgage payment, property insurance and other bills tied to homeownership, PMI is used more often than you might know: Private mortgage insurers provided insurance coverage for a whopping $270 billion in new mortgages in 2016 alone, according to the Housing Finance Policy Center.
But what is private mortgage insurance, how much does it cost and how does it work? Here’s a comprehensive look at the key factors involved with PMI and how to put it to use to buy your new home.
What Is Private Mortgage Insurance?
Most lenders require home buyers to put down about 20 percent of their home’s purchase price to qualify for a conventional (nongovernmental) loan. This can be a hefty commitment for consumers, especially first-time buyers steadfastly saving each month but still having difficulty amassing a large savings pot. In fact, 61 percent of first-time buyers made a down payment of 6 percent or less, according to the National Association of Realtors.
This is where PMI comes in. If buyers can’t afford the 20 percent down payment or need to siphon some of their savings for other homeownership expenses, lenders may still provide them with a conventional loan as long as they take out PMI.
PMI allows borrowers to qualify for a conventional loan even if they put down 5 percent up to 19.99 percent. It’s typically arranged by the lender and issued by private insurance companies. PMI is classified as “private” to distinguish it from government-backed loans and insurance.
To be clear, while you’re paying for the insurance, the coverage isn’t for you. It serves to lower a loan’s risk to lenders. If you can’t put 20 percent down, lenders may see you as a high-risk client. The PMI is to protect lenders in case you default on your loan.
How Much Does Private Mortgage Insurance Cost?
PMI costs vary, depending on a variety of factors, including your down payment, mortgage size, loan-to-value ratio and credit score.
Most lender websites quote that it will range from 0.25 percent to as high as 2.25 percent of your outstanding loan balance each year — so the bigger your mortgage, the higher your PMI premiums.
Other factors include whether your interest rate is fixed or adjustable; how big your mortgage is; long the loan term is; whether it’s your first home, second home or a property investment; and the amount of coverage your lender needs. As always, when it comes to insuring loans, the riskier that lenders perceive you, the higher the premiums you’ll have to pay. A buyer with a great credit score who is putting 15 percent down on a 10-year fixed-rate mortgage will snag lower PMI premiums compared to their counterpart putting 5 percent down on a 30-year variable-rate mortgage, for example.
There are six PMI companies in the United States, and across the board, they charge similar rates. If your lender decides you’ll need to pay for PMI, they’ll arrange it through one of these insurance providers. Before your loan closes, you’ll know precisely how much you’re committing to in PMI costs and for how long.
PMI doesn’t come cheap. I you have a mortgage of $200,000, your PMI could cost you between $1,100 and $4,500 annually, or roughly $92 to $375 each month. You can expect to pay between $30 and $70 per month for every $100,000 borrowed, according to Freddie Mac. This PMI expense is on top of keeping up with your monthly mortgage payments, property taxes and other maintenance fees.
If you’re vying for a lower PMI rate, there are a few things you can do to tip the rates in your favor. For starters, get your credit score in great shape by staying on top of all of your payments due dates to creditors. Choose a home that isn’t as pricy so you have a smaller mortgage and lower loan-to-value ratio, and throw as much as you can at your down payment so you’re as close to the 20 percent mark as you can be.
How Do Private Mortgage Insurance Payments Work?
PMI payment options will vary depending on the lender; some offer payment options while others have a fixed policy.
For the most part, consumers pay for their PMI payments in two different ways: as a lump sum payment each year, known as single-payment mortgage insurance, or as an expense rolled into their monthly mortgage payments, known as borrower-paid mortgage insurance.
With single-premium mortgage insurance, your mortgage insurance is paid in one fell swoop when your loan closes. Because you’re paying up front, your monthly mortgage payment will be lower overall. It can be tricky to afford, though. If you’re cash-strapped, paying a lump sum for the year ahead may not be feasible. The other downside is that if you decide to refinance or sell your home, your lump sum payment isn’t refundable.
Borrower-paid mortgage insurance is worked into your monthly mortgage payments, making the expense more palatable.
Finally, a third, hybrid option combines both options: You make a partial up-front payment and pay the remainder in your monthly mortgage bill.
If your lender decides your need to pay PMI to qualify for your loan, talk to them about your payment options.
Your lender can provide you with a cost breakdown for each option to help you decide which is most feasible and cost-effective depending on your circumstances. Your loan documentation should outline your PMI premiums and projected payments so you know precisely what you’re getting yourself into.
When Do I Stop Making PMI Payments?
As a rule of thumb, your PMI premiums typically terminate once you have more than 20 percent equity in your home, or when you’ve built enough equity that your lender no longer deems you as high-risk. This could take years, depending on how much your mortgage payments are and how much money you’re funneling into building equity in your home. Reports suggest the magic number is 11 years, on average.
You can take the initiative and request to stop your mortgage insurance payments once your loan-to-value ratio drops below 80 percent. When you ask to terminate your PMI, make sure you have a solid mortgage payment history and you don’t have any liens on your home. In some instances, lenders may ask for an up-to-date home appraisal to gain current insight into your home’s value.
Regardless, once your loan-to-value ratio hits 78 percent, your lender automatically cancels your PMI, according to the Homeowners Protection Act.
Another option is to check your home’s appreciation in value. If you’ve built further equity in your home due to appreciation, your PMI could be canceled too. You’d have to prove this, again, through an appraisal.
What If I Don’t Want to Pay for Private Mortgage Insurance?
You have some wiggle room if you decide that PMI is an added expense you’re not interested in. As we outlined earlier, you can avoid it altogether by putting 20 percent down at the outset, and committing to a less expensive home and in turn a smaller mortgage.
You can also consider other low down payment loans that don’t require PMI. The catch? Slightly higher interest rates on your mortgage. PMI Advantage from Quicken Loans, for example, waives the need for PMI for mortgages with less than 20 percent down, but you’ll pay for the difference in a higher interest rate.
Bank of America offers the Affordable Loan Solution for “modest-income” and first-time buyers. With this program, buyers can secure mortgages with only 3 percent down and without PMI. Bank of America noted some caveats, though: Buyer education may be required, especially for first-time buyers; loan limits may apply depending on the location; and PMI may stay on the table but at a reduced cost compared to conventional loans.
Finally, if you qualify, it’s worth considering government-backed loans, namely the Veteran Affairs home loans. VA home loans are offered by the Department of Veterans Affairs to help veterans buy, build or improve a home or refinance current home loans. Because they’re government-backed, nearly 90 percent of all VA loans are extended without a down payment and, across the board, don’t require mortgage insurance.
Federal Housing Administration loans require mortgage insurance, but they’re worth considering because rates can be lower than PMI.
Is Private Mortgage Insurance Worth It?
The answer depends on the individual. Yes, PMI is another expense to consider, but it can help get your foot in the homeownership door so you don’t have to wait until you’ve accumulated enough for 20 percent down. If you have a great credit score and your loan isn’t substantial, you may be able to secure a lower PMI rate.
You’ll need to do some number crunching to evaluate how much you’ll be spending each year on PMI, property taxes and interest on your mortgage. If the value of your home appreciates quickly, those expenses may be worthwhile — rising home prices is the prime reason why consumers park their savings in bricks and mortar.
On the other hand, you could keep renting and saving up for what’s to come as a homeowner. But in that time, you’re staying off of the property ladder as home prices could continue to increase.
Don’t forget the personal factors, and other factors impacting mortgages. For some people, homeownership is a key milestone they want to reach by a certain age, while for others the stability is important for a young family, so PMI may be worth it to get into a home. Choosing to take out PMI requires careful consideration but it’s a great tool to have if you decide it’s your ticket to securing a mortgage.
Carmen Chai is an award-winning Canadian journalist who has lived and reported from major cities such as Vancouver, Toronto, London and Paris. For NewHomeSource, Carmen covers a variety of topics, including insurance, mortgages, and more.