What is pmi on a home loan

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There’s so much to think about when buying a home. You want to choose the right neighborhood, get the lowest mortgage rate possible and find a property with all your desired amenities. But before you get too wrapped up in the details of homebuying, take a step back and consider how private mortgage insurance might fit into the equation. It’s not exactly cheap, after all.

What Is Private Mortgage Insurance?

Private mortgage insurance, or PMI, is a type of insurance coverage required by some lenders when the mortgage borrower doesn’t make a large enough down payment. This mortgage insurance doesn’t actually protect you in any way. Instead, it’s there to protect the lender from a major financial loss in case you’re unable to repay your loan. If the property goes into a short sale or foreclosure auction and there isn’t enough equity built up to cover the loss, PMI serves as a way to fill the gap.

4 Key Questions About PMI

If the idea of paying private mortgage insurance gives you pause, it should. PMI is an avoidable extra cost associated with buying a home.
That said, sometimes paying PMI is the right move; it can help you get into a home that would otherwise be out of reach. So before you make the decision to take out a home loan that includes PMI, learn the answers to these four key questions first.

1. Who Needs PMI and Can I Avoid It?

Private mortgage insurance is required by conventional mortgage lenders when the down payment on a home loan is less than 20% of the purchase price, or when you refinance with less than 20% equity. Some government-backed loans, such as FHA loans, also require mortgage insurance, though it works a bit differently.

The easiest way to avoid paying PMI is putting down at least 20% on a home loan. In addition to avoiding PMI, a large down payment also gives you stronger financial footing and may allow you to borrow less and/or qualify for more affordable loan terms.

On the other hand, saving up 20% of your home’s value can be easier said than done. The median home price in the U.S. was $295,300 as of June 2020, which means you’d need at least $59,060 saved to start house hunting. Depending on your personal financial situation and lifestyle, that may or may not be realistic. In high cost of living cities such as San Francisco or New York, where a home can easily cost $1 million or more, you’d need at least $200,000. And if home values in your area are rising at a pace faster than you can save, you may never be able to reach that full 20%.

That’s why paying PMI isn’t necessarily a bad thing if you can easily afford it. But if PMI would strain your budget or cause you to spend significantly more on a home than you’d like, it’s a good idea to avoid it.

2. How Much Does PMI Cost?

The cost of private mortgage insurance ranges depending on the particular lender and how much money you actually put down on the loan. PMI is calculated as a percentage of your total loan amount and generally ranges between 0.58% and 1.86%. The larger your loan, the more PMI you will end up paying.

The cost of PMI is also influenced by your loan-to-value ratio (LTV). This represents how much you’re borrowing in comparison to the total value of the property. The more you put down, the less you need to borrow, which gives you a higher LTV. For example, if you put 20% down on a home, your LTV should then be 80%. A smaller down payment—and thus, lower LTV—likely will require you to pay PMI until you reach that 80% mark. The lower your LTV, the higher the risk for the lender, which is why the cost of PMI often increases as your LTV decreases.

Finally, your credit score also can influence the cost of PMI. The higher your score, the less risk you represent to lenders, so it may be possible to qualify for lower PMI with good credit.
Let’s look at an example of how much PMI can cost:

Say you purchased a home for $500,000 and only put 10% down ($50,000). That means you borrowed a total of $450,000. Your lender charges you PMI of 1%, for an annual premium of $4,500 or $375 per month.

The good news? PMI is currently tax deductible. Previously, you could only deduct PMI through 2017. However, thanks to the Further Consolidated Appropriations Act of 2020, Congress extended the deduction through Dec. 31, 2020. That means you can deduct PMI for tax years 2019 and 2020, as well as retroactively for 2018.

3. How Do I Pay PMI?

Your lender will arrange PMI through its own network of insurance providers. The terms of the plan, including cost and length of time you’re required to pay it, will be provided to you at closing.

You can choose to pay the premium up-front as part of your closing costs, and then annually until you’re no longer required to pay it. Alternatively, you can roll the premium into your loan and make monthly payments on top of your regular loan payments. Keep in mind that if you split up the payments, however, you’ll pay interest on them, too. This can cause PMI to be much more expensive than you realize.

4. How Do I Get Rid of PMI?

Fortunately, there are a few ways to eventually get rid of PMI if you’re required to pay it now. The first is consistently making payments until you have 20% equity in your home—or an LTV of 80%—at which point the lender is required to cancel it. However, this doesn’t happen automatically; you should contact your lender and ensure that PMI is indeed canceled once you meet the qualifications.

Another situation in which you no longer need to pay PMI is if your home value increases and you now have more than 20% equity built up. In this situation, your LTV might reach 80% faster than you were originally required to pay PMI. If that happens, great. You should have your home reappraised, and if you owe less than 80% of the newly appraised value, it’s time to get in touch with your lender to have your PMI canceled. Keep in mind that you are responsible for the costs associated with having your home appraised in this situation.

Finally, if your cash flow has unexpectedly increased and you can afford to pay off your mortgage faster, you may consider doing so—at least for a few months. By making extra payments toward your loan, you can pay down the principal faster and reach an LTV of 80% sooner than originally planned.

Though you probably love the thought of getting rid of PMI as soon as possible, be sure to first crunch the numbers and be sure that’s the best plan of action. Paying extra toward your mortgage should be a better financial move than using the funds for other purposes, such as paying off other high-interest debt.

How long do you pay PMI?

How much is PMI on a $500000 loan?

When can I get rid of PMI?

Does PMI fall off after 20%?