If you are planning to buy a home with a down payment of less than 20%, you have likely heard the term "PMI." For many first-time homebuyers, Private Mortgage Insurance (PMI) comes as an unwelcome surprise that adds hundreds of dollars to their monthly payment.
In this guide, we will explain exactly what PMI is, why lenders require it, and the most effective strategies to avoid paying it or get rid of it as quickly as possible.
What is PMI (Private Mortgage Insurance)?
Private Mortgage Insurance (PMI) is a type of insurance that protects the lender, not you, the borrower. If you stop making payments and the lender has to foreclose on the home, PMI helps the lender recover some of its financial losses.
Because a low down payment means the lender is taking on more risk, they require PMI to safeguard their investment. Typically, PMI is required on conventional loans when your down payment is less than 20% of the home's purchase price.
How Much Does PMI Cost?
The cost of PMI varies based on your credit score, the size of your down payment, and the lender. However, it generally ranges from 0.3% to 1.5% of your original loan amount annually.
For example, on a $300,000 loan, a 1% PMI rate would cost you $3,000 per year, which is an extra $250 added to your monthly payment.
How to Avoid PMI
Nobody wants to pay for insurance that doesn't protect them. Here are the most common ways to avoid PMI altogether:
1. Save for a 20% Down Payment
The simplest way to avoid PMI is to put down 20% of the home's purchase price. While saving this much can take time, it saves you money in the long run by lowering your loan amount and eliminating the monthly PMI premium.
2. Use a "Piggyback" Loan (80-10-10)
If you have 10% to put down but want to avoid PMI, you can take out a primary mortgage for 80% of the home's value and a second "piggyback" loan (like a home equity loan or HELOC) for the remaining 10%. This structure covers the 20% down payment requirement without triggering PMI.
3. Look for Lender-Paid PMI (LPMI)
Some lenders offer "Lender-Paid PMI." In this scenario, the lender pays the PMI on your behalf, but in exchange, they charge you a slightly higher interest rate. This is good if you plan to stay in the home for a long time, but it may cost more in total interest over the life of the loan.
4. VA Loans
If you are a qualifying veteran, active-duty service member, or surviving spouse, a VA loan is one of the best options. VA loans are backed by the Department of Veterans Affairs and do not require PMI, even with a $0 down payment.
How to Get Rid of PMI
If you are already paying PMI, don't worry — it doesn't last forever. As you pay down your mortgage and your home's value increases, you can get rid of it in a few ways:
1. Automatic Termination at 78% LTV
Under the federal Homeowners Protection Act, your lender must automatically cancel PMI when your loan balance reaches 78% of the original home value, provided you are current on your payments.
2. Request Cancellation at 80% LTV
You can request that your lender cancel PMI once your loan balance drops to 80% of the original value. You will usually need a good payment history and may need to provide a written request.
3. Refinance Your Mortgage
If your home's value has increased significantly since you bought it (due to market appreciation or renovations), you may have reached 20% equity. You can refinance into a new loan without PMI. However, be sure to factor in closing costs and the new interest rate.
Conclusion
PMI is a necessary cost for many buyers who want to enter the housing market without a massive down payment. While it adds to your monthly expenses, it allows you to buy a home sooner. By understanding how PMI works and knowing your options, you can plan to eliminate it as soon as possible.
Use our mortgage calculator to see exactly how much PMI is adding to your monthly estimate, and try different down payment amounts to see how it affects your total cost.