What is PMI on a mortgage and how does it work?
Key takeaways
- PMI protects the lender, not the borrower, on conventional loans with less than 20 percent down.
- You can ask to cancel it at 80 percent of the home's original value, and it ends on its own at 78 percent.
- A new appraisal can end PMI early if rising home values have pushed your equity past 20 percent.
Private mortgage insurance, usually called PMI, is insurance you may have to buy when you take out a conventional loan with a down payment of less than 20 percent of the purchase price. It protects the lender, not you, if you stop making payments on your loan.
That one fact surprises many buyers. You pay the premium, but the lender is the one covered. PMI exists because a small down payment means a bigger loan relative to the home's value, which means more risk for the lender.
This article explains what PMI is, when you pay it, how much it costs, how you pay it, how it compares with other options, and how to cancel it.
What PMI is and who it protects
The Consumer Financial Protection Bureau defines PMI as a type of mortgage insurance you might be required to buy with a conventional loan when your down payment is less than 20 percent of the purchase price. PMI is arranged by the lender and provided by private insurance companies.
It insures the lender against loss caused by borrowers failing to make loan payments. If you fall behind, PMI does not protect you, and you can still lose your home through foreclosure.
So why would anyone agree to pay for it? Because PMI can help you qualify for a loan you might not otherwise be able to get. The trade-off is that it raises the cost of your loan.
The requirement usually applies to refinancing too. When you refinance a conventional loan and your equity is less than 20 percent of the home's value, PMI is usually required again.
When you have to pay PMI
PMI comes with conventional loans when your down payment is under 20 percent. When you pay 20 percent down, PMI is not required on a conventional loan, and you could also get a lower interest rate.
That 20 percent line is the key number for this whole topic. Everything about PMI, from when it starts to when it ends, turns on how much of the home you own versus how much you still owe.
Other loan programs have their own mortgage insurance rules. FHA loans, for example, carry their own insurance structure, and VA loans work differently again. Comparing those programs against a conventional loan with PMI is part of shopping for a mortgage.
Your lender should show you the PMI cost up front. The premium appears on your Loan Estimate and Closing Disclosure, so you can see it before you commit.
How much PMI costs
PMI typically costs about 0.5 to 1.5 percent of the loan amount per year, according to mortgage guides that track PMI pricing. That annual premium is broken into monthly installments and added to your monthly mortgage payment.
On a 300,000 dollar loan, that range works out to roughly 1,500 to 4,500 dollars per year, or about 125 to 375 dollars per month. Your exact premium depends on your credit score, your down payment, and the insurer's pricing.
Borrowers with stronger credit and larger down payments generally pay less. A borrower putting 15 percent down with a high credit score pays far less per month than a borrower putting 3 percent down with a weaker score.
That monthly cost is worth weighing against the alternative of waiting years to save a full 20 percent down payment. During those years, home prices can rise, and you keep paying rent. PMI is the price of buying sooner.
How you pay for PMI
The most common way to pay for PMI is a monthly premium. The premium is shown on your Loan Estimate and Closing Disclosure on page 1, in the Projected Payments section, and it is added to your mortgage payment.
Sometimes you pay for PMI with a one-time up-front premium paid at closing. That premium appears on page 2 of the same documents, in section B. If you make an up-front payment and then move or refinance, you might not be entitled to a refund.
Sometimes you pay with both up-front and monthly premiums. Lenders might offer you more than one option, and the CFPB suggests asking your loan officer to help you calculate total costs over a few realistic timeframes.
Before agreeing to a mortgage, ask lenders what PMI choices they offer. The cheapest structure depends on how long you plan to stay in the home and whether you expect to refinance.
How PMI compares with other options
Lenders sometimes offer conventional loans with smaller down payments that do not require PMI. As a trade-off, you usually pay a higher interest rate for these loans.
Paying a higher interest rate can be more or less expensive than PMI, depending on how long you plan to stay in the home. A higher rate lasts as long as you keep the loan, while PMI can be cancelled. Since mortgage rates move with bond markets rather than Fed headlines, the rate you lock also matters to the comparison.
Borrowers making a low down payment might also want to consider other types of loans, such as an FHA loan. Other loan types may be more or less expensive than a conventional loan with PMI, depending on your credit score, down payment, lender, and market conditions.
You might also consider saving up for a 20 percent down payment. When you pay 20 percent down, PMI is not required with a conventional loan, and you could receive a lower interest rate. The cost of waiting is the time spent saving.
The CFPB also suggests asking a tax advisor whether paying more in interest or paying PMI might affect your taxes differently. Tax rules change, and the answer depends on your situation.
How to cancel PMI
Federal law gives borrowers rights to remove PMI on many mortgages. The Homeowners Protection Act sets out the two main milestones.
You have the right to request that your servicer cancel PMI when you have reached the date when the principal balance of your mortgage is scheduled to fall to 80 percent of the original value of your home. That date should have been given to you in writing on a PMI disclosure form when you received your mortgage.
Even if you do not ask to cancel, your lender must terminate PMI on the date when your principal balance is scheduled to reach 78 percent of the original value of your home. That automatic end is a backstop, not something you have to chase.
If you pay only the minimum of your monthly mortgage payment, it can take quite a few years to reach those milestones on a conventional loan. Extra principal payments move the date earlier.
How to get rid of PMI early
A new appraisal can end PMI before the scheduled dates. Some lenders may let you pay for a new appraisal and drop PMI if the appraisal shows at least 20 percent home equity.
Erin Lantz, vice president of mortgages at Zillow, told Clark.com that it can make sense for homeowners paying PMI to have their home re-appraised to find out whether they have built up enough equity. The monthly savings, she said, could be more than enough to offset the cost of the appraisal.
Clark Howard, the consumer advocate behind Clark.com, put the lender's view bluntly. He described PMI as an insurance premium for the lender, since borrowers who put down less than 20 percent are more likely to face foreclosure when times get tough.
His practical advice is to know your area. If home values around you have risen sharply, it may be worth spending several hundred dollars on an appraisal to drop PMI. First, call your lender to ask about its options and to request a list of approved appraisers.
Not every loan qualifies for appraisal-based cancellation, and your servicer sets the rules. Ask in writing what your servicer requires before you pay for an appraisal.
Frequently asked questions
Does PMI protect me if I cannot pay?
No. PMI protects the lender, not you. If you fall behind on payments, you can still lose your home through foreclosure even while PMI is in force.
Does PMI go toward my principal?
No. PMI premiums pay for insurance coverage for the lender. They do not reduce your loan balance or build your equity.
How long does PMI last?
It lasts until you reach the cancellation milestones. You can request cancellation at 80 percent of the home's original value, and it ends automatically at 78 percent. An appraisal showing 20 percent equity can end it sooner with some lenders.
Can I avoid PMI without 20 percent down?
Sometimes. Some lenders offer no-PMI loans at a higher interest rate, and other loan programs have different insurance rules. Compare total costs over your expected time in the home before choosing.
What happens to PMI if I refinance?
Refinancing starts a fresh loan, and PMI rules apply again based on your equity at that time. If your equity has reached 20 percent, the new loan may not need PMI at all.
The bottom line
PMI is the cost of buying a home before you have saved a 20 percent down payment. It protects your lender, adds a monthly cost, and ends once your equity reaches the legal milestones or an appraisal proves you have crossed them.
Track your balance against the home's original value, keep your PMI disclosure form, and ask your servicer about cancellation as soon as you approach 80 percent. This article is for general information, not financial advice.
Tags: mortgages, PMI, home buying, down payment
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