What is Private Mortgage Insurance?

Dreaming of buying a home? If you don’t have a 20% down payment on the home’s purchase price, lenders will require you to get private mortgage insurance. Private mortgage insurance protects the lender in case a borrower defaults on the mortgage. 

This is used to protect both the borrower and the lender. The borrower gets a home and can build equity with a smaller downpayment, while the lender has protection in case of default. Read on to understand how private mortgage insurance works. 

How Does Private Mortgage Insurance Work?

Private mortgage insurance (PMI) is insurance required of mortgage borrowers in many cases. Borrowers who cannot put 20% down on the home generally have to get private mortgage insurance. 

Mortgage lenders use a ratio called the loan-to-value (LTV) ratio to determine the risk of a loan. The higher the LTV, the greater the risk. On any property with less than a 20% down payment, the LTV will be over 80%.

Unlike other insurance you might get, such as auto, health or property insurance, PMI protects the lender, not you. Other insurance policies usually pay you. PMI will pay the lender if you fail to pay. Why would you get PMI? Because it makes it possible to become a homeowner sooner. When your loan is no longer considered high risk because of built-up equity in the home, you will no longer be required to carry PMI. 

Related to PMI, if you qualify for a Federal Housing Administration loan (FHA loan), you may be required to get FHA mortgage insurance. 

Determining the Need for PMI

Mortgage lenders use a ratio called the loan-to-value (LTV) ratio to determine the risk of a loan. The higher the LTV, the greater the risk. Any property with less than 20% down payment will require PMI. In addition, lenders may look at your credit score, payment history, savings, and other assets when determining the need for private mortgage insurance. 

How Much Does PMI Cost?

Private mortgage insurance comes with additional costs. PMI costs usually range from 0.5% to 2% of your yearly loan balance. The exact amount depends on the down payment amount, loan terms and your credit score. On a $250,000 loan, PMI could cost $1,250 to $5,000 per year.

Types of Private Mortgage Insurance

You can consider various private mortgage insurance options, from single-premium to split-premium. Read on to understand each and what they mean for you:

Single-Premium Mortgage Insurance

Single-premium mortgage insurance (SPMI) requires you to pay mortgage insurance upfront in a lump sum. You’ll need to pay the single premium at closing, or it may be built into the mortgage. While borrower-paid mortgage insurance is more common, SPMI offers interesting benefits. Your monthly payment will be lower, potentially qualifying you to borrow more. You don’t have to worry about canceling the PMI, as it’s all paid upfront. 

If you decide to refinance or sell within a few years, you won’t get that single premium back. But it could still lead to long-term savings. You can speak with the lender about the total costs of different private mortgage insurance options to see which will save you more. 

Borrower-Paid Mortgage Insurance

Borrower-paid mortgage insurance (BPMI) is the most common type of private mortgage insurance. With borrower-paid mortgage insurance, you’ll pay a monthly fee in addition to your mortgage payments. You’ll pay BPMI until you have built up 22% equity in the home based on payments to the original purchase price. The good news is that at that point, the lender will automatically cancel the BPMI. The bad news? This takes around 15 years for most homebuyers. 

Once you’ve reached 20% equity in the home, you could ask the lender to cancel BPMI. To do this, your mortgage payments must be current with a strong payment history.  Some lenders may request a new property appraisal before canceling the borrower-paid mortgage insurance.

Lender-Paid Mortgage Insurance

As the name implies, the lender pays the insurance premium with this type of private mortgage insurance. But that’s semantics — you’ll pay the lender for this convenience through higher mortgage interest rates. With lender-paid mortgage insurance, refinance is the only way to cancel it. It’s not refundable. In many cases, lender-paid mortgage insurance leads to a lower monthly premium, saving you more or allowing you to borrow more. 

Split-Premium Mortgage Insurance

Split-premium mortgage insurance is relatively uncommon. It combines single-premium and borrower-paid mortgage insurance. With this option, you will pay part of the mortgage insurance as a lump sum upfront at closing. You'll pay the rest as a monthly payment. This is an attractive option for borrowers who can't come up with enough for a single premium payment. It won't increase your monthly payments as much as borrower-paid mortgage insurance. 

Borrowers with a high debt-to-income ratio can use split-premium mortgage insurance to keep their monthly debt lower and help qualify for a mortgage without paying the full premium upfront. 

For split-premium mortgage insurance, you can expect to pay 0.5% to 1.25% of the loan amount as a lump sum upfront. The monthly premium will be based on the net loan-to-value ratio.

Federal Home Loan Mortgage Protection

Federal home loan mortgage protection is only used for loans underwritten by the Federal Housing Administration. If you get an FHA mortgage, you’ll need a private mortgage insurance called mortgage insurance premium or MIP. 

You’ll need an MIP on all FHA loans with down payments of 10% or less. MIP requires both an upfront payment and monthly premiums. You will need to wait 11 years before you can remove MIP.

Benefits and Limitations of PMI

Private mortgage insurance has significant pros and cons for homebuyers. The main advantage is that it allows buyers with less than 20% down payment to secure a home. The primary drawback is the additional cost to borrowers upfront and over the loan’s lifetime. 

Pros of PMI:

• Buy with a lower down payment
• Buy the house you love with a lower down payment
• Keep more money in the bank
• A PMI doesn’t last forever

Cons of PMI:

• Higher monthly costs
• A PMI protects the lender, not you

How to Avoid Paying PMI

The primary way to avoid paying private mortgage insurance is to get a downpayment of at least 20%. For FHA loans, you’ll only need 10%. Other strategies to avoid PMI include:

• Look for an 80-10-10 loan that allows you to put 10% down and take out a 10% home equity line of credit to satisfy the 20% down payment.
• Check whether your lender will waive the PMI if you pay a higher interest rate.
• Buy a less expensive home, so you have a higher down payment amount.
• Shop for a loan that doesn’t require PMI.
• Check state and local homebuyer assistance programs.

Compare Mortgage Lenders

If you’re ready to secure a mortgage, here is a comparison of available lenders. 

Taking the Next Steps to Buy a Home

Private mortgage insurance can open homeownership to more buyers. By removing the obstacle to entry of 20% down, you can enter the housing market and build equity in a home. You can work with a mortgage lender and research ahead of time to find the best interest rates and reduce total costs. Ready to explore more options? Find interest-only mortgages here. 

Frequently Asked Questions