What is private mortgage insurance (PMI)? Definition, cost, and how to avoid it
What is private mortgage insurance (PMI)? Definition, cost, and how to avoid it.
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Private mortgage insurance (PMI) is insurance that protects the lender if you don't make payments on your home loan. If you're putting less than 20% down on a home and taking out a conventional loan, you generally have to pay this cost at closing or as part of your monthly mortgage payments.
PMI is a form of mortgage insurance that applies to conventional loans . If you buy a home with a conventional loan and your down payment is less than 20% of the home's value, buying PMI is mandatory. Lenders also require you to buy PMI if you're refinancing with a conventional loan and you have less than 20% equity in the home.
Lenders set up your PMI with private insurance companies that offer it, and the cost is listed on your loan estimate and closing disclosure.
PMI is there to protect the lender, not the borrower. If you don't make your mortgage payments, the lender can recoup some of the money they're owed from the insurer. But you're not protected from late payment fines or foreclosure.
Indirectly, PMI may be helpful to borrowers because it offers a path to homeownership for those who don't have the funds for a large down payment.
"In the event of a loan defaulting, a lender gets some of their money back in that situation, but the benefit is borrowers no longer have to put 20% down when buying a home. So it's a very important tool in the industry to help people get into homes," says Daniel Iglesia, director of mortgage sales at Georgia's Own Credit Union.
You need to pay PMI when you buy a home with a conventional loan and make a down payment of less than 20%, or when you refinance with a conventional loan and your equity is below 20%.
PMI doesn't apply to government-backed loans. Instead, you pay other types of mortgage insurance on loans guaranteed by the FHA, USDA or VA:
FHA loans. You have to pay both an upfront and monthly mortgage insurance premium on an FHA loan . The monthly mortgage insurance premium generally stays in place for the life of the loan if your down payment was less than 10%.
USDA loans. You pay an upfront guarantee fee and an annual guarantee fee on a USDA guaranteed loan , which serve a similar purpose to mortgage insurance. These fees can't be removed. You don't owe mortgage insurance on a USDA direct loan.
VA loans. You pay a funding fee that varies by down payment size and whether it's your first time using the VA loan benefit. You may not owe the fee if you qualify for an exemption, such as if you receive VA compensation for a disability related to your service.
Dozens of factors can influence your PMI rate, but the two most important ones are your loan-to-value ratio and your credit score.
Your loan-to-value ratio is your loan amount expressed as a percentage of your home's value. A lower down payment results in a higher loan-to-value ratio, which means more risk for the lender. Thus, a larger down payment can help you get a better rate on PMI.
To see the impact of down payment size on your rate, take a look at an example. Suppose you buy a $400,000 home with a 30-year loan and a 7% interest rate. Your PMI premium can drop dramatically if you put more money down, based on calculations from Freddie Mac.
Lenders and private mortgage insurers also see a borrower with a better credit score as less risky, and PMI rates reflect that.
"Somebody who has a 780 credit score is going to have a lot lower PMI than somebody who has a 680 credit score. And that could make a world of difference in the amount that you're charged," Iglesia says.
You don't have to pay monthly PMI premiums over the entire life of your home loan. You can request to get rid of PMI once you've built enough equity, or it will be removed later by the lender.
