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What Is Private Mortgage Insurance (PMI)?
Private mortgage insurance (PMI) is a type of insurance policy that protects lenders from the risk of default—or nonpayment by the borrower—and foreclosure. PMI helps homebuyers who are either unable or choose not to make a significant down payment obtain mortgage financing at an affordable rate. If a borrower purchases a home and puts down less than 20%, the lender will require the borrower to buy insurance from a PMI company prior to signing off on the loan.
Key Takeaways
- Private mortgage interest (PMI) is required when the down payment on a house is under 20% of the selling price.
- As of 2020, the rate varies between 0.5% and 1.5% of the loan.
- You can pay PMI in monthly installments or as a one-time payment, though the rate for a single payment would be higher.
Understanding Private Mortgage Insurance (PMI)
PMI benefits the lender (the sole beneficiary of PMI), but it can add up to a sizable chunk of your monthly house payments. Typically, you send one payment to your lender each month to cover both the mortgage (principal plus interest) and the insurance premium. PMI rates can range between 0.5% and 1.5% of the loan amount on an annual basis.
Your PMI rate will depend on several factors, including:
Down Payment
PMI will cost less if you have a larger down payment (and vice versa). If a borrower puts 3% down versus a 10% downpayment, it means many more months of making PMI payments to the bank.
Credit Score
A borrower’s credit score is a numerical representation of a person’s creditworthiness, and the ability to pay back a loan on time and in full. A credit score can range from 300 to 850 and is based on a person’s credit history, which includes the number of late payments and the total amount of debt outstanding. The higher the score, the more creditworthy a borrower appears to banks and mortgage lenders. As a result, the higher the credit score, the lower the PMI premium.
Potential for Property Appreciation
If you live in a market with declining property values, your PMI premium might be higher. Conversely, if you live in an area where home values are appreciating, the value of the home could increase enough for you to stop the PMI payments. A new home appraisal would be needed, but if the value has risen over 20%, for example, you would no longer need to pay PMI.
Loan Type
Different loan types can come with different PMI rates. For example, a conventional mortgage, which is a loan issued by a bank, might have a higher PMI than an FHA loan. An FHA mortgage is a Federal Housing Administration loan, which is insured by the Federal Housing Administration (FHA). FHA mortgage loans are issued by FHA-approved lenders and are designed to help first-time homebuyers and those with low-to-moderate-incomes.
Borrower Occupancy
If the financed property will be owner-occupied (you will be living there), your PMI premium will be lower than if it is a rental or an investment property.
Three Years
The amount of time you need to live in a home that makes a single, up-front PMI payment the more affordable option.
Example of Private Mortgage Insurance (PMI)
Assume you have a 30-year, 2.9% fixed-rate mortgage for $200,000 in New York. Your monthly mortgage payment (principal plus interest) would be $832.00. If PMI costs 0.5%, you would pay an additional $1,000 per year or (.005 * $200,000). As a result, your monthly PMI payment would be $83.33 each month, or ($1,000/12), increasing your monthly payment to $915.33.
You may also be able to pay your PMI upfront in a single lump sum, eliminating the need for a monthly payment. The payment can be made in full at the closing or financed within the mortgage loan. In many cases, this is the more affordable option as long as you plan on staying in the home for at least three years. For the same $200,000 loan, you might pay 1.4% upfront, or $2,800. However, it’s important to consult your lender for details on your PMI options and the costs before making a decision.