Published on September 24, 2020
Explained: Private Mortgage Insurance and Why PMI Isn't Always Bad
Written by The Servion Group
Private mortgage insurance, or PMI, is one of those things that many home buyers find somewhat mystifying. As a result, loan officers often find themselves answering questions about PMI, such as:
- What is PMI?
- Why do I have to pay PMI?
- How much does PMI cost?
- What are the good and bad aspects of having to pay PMI?
- How do I get rid of PMI?
In this article, we'll walk through some PMI basics and explain how this cost, which most borrowers view as a bit bothersome, isn't always a bad thing.
What is PMI?
To put it in basic terms, PMI is private mortgage insurance on a conventional home loan. Lenders require it to protect themselves in cases where the buyer has less than a 20 percent stake in the home.
Now, PMI as we're discussing it in this article is the kind that is required on conventional loans. Other types of mortgage insurance may be required for borrowers who get a different type of loan. For example, someone getting an FHA loan may need to pay a mortgage insurance premium, or MIP. It's a similar concept to PMI, but goes by a different name and works slightly differently.
For simplicity's sake, we're going to stick to talking about PMI on conventional loans, since that's the most common.
Why Do I Have to Pay PMI?
Many buyers find it strange that they have to pay PMI; after all, it's insurance, but it doesn't seem to protect the buyer who is paying for it. And it's true, PMI protects the lender and the investor.
The lender and investor are taking the risk that the buyer will actually make their loan payments, and so the lender and investor need protection in case a buyer fails to pay. When a failure to pay occurs, the PMI policy steps in and covers the cost associated with delinquency and foreclosure.
How Much Does PMI Cost?
The easiest way to answer this is by thinking about down payments. Let's say someone wants to buy a house for $275,000 with a conventional loan. To avoid paying PMI, the buyer must put down at least 20 percent, or $55,000. That is a huge amount of cash for most people, and it's why saving for a down payment is so hard for many people. (Check out these savings tips!).
If a buyer can't afford the 20 percent down payment, PMI is required.
The cost of PMI, in most cases, gets factored into the monthly payment along with principal, interest and the other costs that go along with any mortgage. PMI premiums vary but are usually between 0.5 percent and 2.25 percent of value of a home each year, according to data from Ginnie Mae and the Urban Institute. For example, if a home costs $275,000 and PMI is 1 percent, then PMI would cost $2,750 a year, or about $228 per month.
Since PMI usually gets factored into the monthly payment, it is not typically something the borrower writes a separate check for. However, there are a few other ways to pay PMI, such as paying it up-front, but they are a little bit beyond the scope of the simple explanation we're providing in this article.
The Good and the Bad of PMI
The obvious thing about PMI that causes people to dislike it is the simple fact that it is another expense that makes home ownership more expensive. It can be hundreds of dollars per month, and that's hard to swallow sometimes.
The bright side of PMI is that it allows more people to purchase homes. Many first-time buyers wouldn't be able to purchase a home because of how hard it is to come up with a 20 percent down payment. Many buyers can afford a monthly payment with PMI included; it's coming up with the down payment that keeps people from buying.
One other thing to note about PMI: it is tax deductible in 2020. It is a good idea to speak with your tax professional to decide whether taking the PMI deduction makes sense in your situation.
How Do I Get Rid of PMI?
Let's stay focused on our basic, most common scenario where a person has a conventional loan with PMI. Homeowners can have PMI removed once the home's equity position hits 20 percent.
You hit 20 percent equity by:
- Making a 20 percent down payment; or
- Over time by making your mortgage payments; or
- A rise in your home's value; or
- Refinancing.
Option 3 is particularly interesting. Homeowners can be proactive about removing PMI, especially in an environment like today's where home values are rising in many markets. The homeowner can request an appraisal from the lender, and if the appraisal shows 20 percent or more home equity, PMI can be removed. Keep the following in mind regarding appraisals:
- If you’ve owned the home for at least five years, and your remaining mortgage balance is no more than 80 percent of the new valuation, you can ask for PMI to be canceled.
- If you’ve owned the home for at least two years but less than five, your remaining mortgage balance must be no greater than 75 percent of the new valuation.
Option 3 and Option 4 often occur together, as an appraisal is frequently done as part of a refinance. A refinance is a new loan which allows homeowners to get a better interest rate, a shorter term or take cash out for a project or other purpose. And because of recent rises in home values in many markets, many homeowners can reap the additional benefit of ditching PMI because they'll have more than 20 percent equity in their homes.
Keep in mind, refinancing isn't always an option for newer homeowners. Many loans have a “seasoning requirement” that requires you to wait at least two years before you can refinance to get rid of PMI. So if your loan is less than two years old, it won't hurt to ask about a PMI-canceling refi, but just know that you might not be eligible yet.
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