If you need a mortgage to buy a house but lack the funds to make a 20% down payment, you might end up paying an added fee called private mortgage insurance, or PMI.
So what exactly is PMI? In the same way homeowners insurance protects you in case of problems in your home, PMI protects your lender in case you default on your loan.
Who needs private mortgage insurance?
There are two types of mortgage insurance: private and government. If you have a government-backed loan, such as an FHA loan, you pay mortgage insurance to the government. If your loan is not government-backed, you pay private mortgage insurance (PMI) to a corporate entity.
Lenders typically require PMI of home buyers if they put down less than 20% of the home’s value. The reason: Lenders see buyers with less money invested in a property as more likely to default on their mortgage and go into foreclosure, so these lenders are trying to protect themselves from that. It’s the trade-off for being able to buy a home with as little as a 3.5% down payment (which is the minimum required for an FHA loan). In case you do default on your mortgage, PMI pays benefits to your lender to cover the loss.
How much private mortgage insurance costs
Expect your PMI payment to range from about 0.3% to 1.15% of your home loan. The most common way to pay PMI loan premiums to your lender is in monthly installments, but you may also be able to make your PMI payments in an upfront cost at your home closing, or roll it into the cost of the loan. Ask your lender for its PMI options. Then do the math for both the long term and short term, and compare it with your home-ownership plans.
How to get rid of private mortgage insurance
Once you have at least 20% equity in your home, you can ask your lender to cancel your PMI. Once you have 22% equity, the lender is required to automatically cancel the coverage.
However, if you have an FHA loan, mortgage insurance payments will last the lifetime of the loan. But these payments last that long only if you keep the loan through its entirety—you can still refinance out of an FHA loan into another PMI-free mortgage when you have at least 20% equity.
How to avoid private mortgage insurance
If your loan isn’t government-backed, PMI payments are not necessarily an absolute. You may be able to avoid PMI payments by doing the following:
- Paying a higher interest rate. This is known as lender-paid PMI. Keep in mind this can’t be canceled and you’ll need to refinance to get a lower rate.
- Using a piggyback loan to cover all or part of the down payment. Piggyback loans come with a higher interest rate, so use caution and do the math.
- Reappraising your house if you think property values and updates have boosted your equity (be aware you’ll need to foot the appraisal bill).
Finally, some lenders may not require PMI for certain loan programs even if the buyer has less than a 20% down payment. These loans usually require sterling credit and other requirements. Consult your lender for more details.
A note on private mortgage insurance tax deductions
PMI has been tax-deductible since the Mortgage Forgiveness Debt Relief Act of 2007—and it's still tax-deductible today! Yes, you'll have to itemize your deductions; but if you do, here's a ballpark figure of how much you'll save: If you make $100,000 and put down 5% on a $200,000 house, you'll pay about $1,500 in yearly PMI premiums—and cut your taxable income by $1,500.