When you buy a home, mortgage lenders generally prefer you make at least a 20% down payment. If you put down less than that, you’ll likely be required to pay for private mortgage insurance (PMI) as part of your monthly mortgage payments.
Although you, the homeowner, pay for PMI, it only protects the lender—not you. It ensures the lender can recover its money if it has to foreclose on your mortgage loan.
This guide explains the basics of PMI and provides insight into how you can avoid it to keep the costs of home buying down.
In this guide:
- What is PMI?
- How much does PMI cost?
- Pros & cons of PMI
- 3 ways to avoid private mortgage insurance
- How to cancel PMI
What is PMI?
Private mortgage insurance is insurance that you buy to protect lenders. If you buy a home with less than a 20% down payment, lenders generally require PMI to ensure they can recoup costs if you don’t repay and they have to foreclose.
Unfortunately, this required additional expense only protects the lender from losses in a foreclosure—not the buyer.
How much does PMI cost?
PMI usually costs between 0.5% to 1% of the loan amount on an annual basis. So, if you borrow $200,000, the cost of PMI on your home could be as much as $1,000 to $2,000 per year, split into monthly payments.
How to pay for PMI
When you are required to pay PMI, the cost of the insurance is included in your monthly mortgage bill. If your home loan costs are $1,000 per month and PMI is $1,000 per year, you would pay an extra $83.33 per month, and your payment would be $1,083.
Pros & cons of PMI
You can buy a home sooner.
PMI enables you to buy a home without a 20% down payment.
Lenders may offer better rates.
Because PMI reduces risk, lenders can offer borrowers better rates and easier qualifying requirements.
You increase the cost of your mortgage payment each month.
You risk owing more than your home is worth if you put down less than 20%, and you could be charged a higher interest rate.
PMI used to be tax-deductible, but that deduction expired at the end of 2017 in favor of the increased standard deduction.
3 ways to avoid private mortgage insurance
Avoiding PMI can save you money. Fortunately, there are a number of ways you may be able to do it.
1. Increase your down payment
The best way to avoid PMI is to make a down payment of at least 20%. This is the most financially sound approach because it also protects you from buying more house than you can afford.
If you cannot afford to save more money, consider buying a cheaper home. This would allow you to more easily make the larger down payment.
2. Explore first-time home buyer programs
Loans guaranteed by the U.S. Federal Housing Administration (FHA loans) don’t require PMI, but do require a different type of mortgage insurance called a an FHA mortgage insurance premium (MIP) that’s actually costlier. You’ll pay both an upfront and monthly premium.
But loans guaranteed by the Department of Veterans Affairs (VA loans) don’t require mortgage insurance even with a low or no down payment.
>> Read more: Best VA Lenders: 0% Down Payments for Veterans
Some states and private organizations also offer down payment assistance, especially for first time home buyers. Taking advantage of these programs could help you get the down payment you need to avoid PMI.
3. Take out a piggy-back loan
You can avoid PMI in some cases by taking out a different kind of loan—a second mortgage or personal loan—to cover your 20% down payment.
>> Read more: Second Mortgage vs Home Equity Loan: Which Is Better?
Some lenders won’t allow this, so check with yours before taking out a loan. And keep in mind that the additional loan will affect your debt-to-income ratio and potentially prevent you from getting a mortgage in the first place.
Taking on this additional debt is not ideal, but saving on monthly PMI premiums could help you to pay down the second loan more quickly.
If you can’t avoid PMI, compare quotes to save
If you cannot avoid PMI, factor that cost in when you compare mortgage lenders. If one lender charges a lower rate, you could save money to apply to your private mortgage insurance.
And if you can’t find a better rate now, try to refinance your mortgage in a few years after you’ve paid down some debts and hopefully improved your credit score.
How to cancel PMI
Lenders are required to cancel PMI automatically once your loan-to-value ratio is down to 78% of your home’s value.
You can also ask your lender to cancel your PMI once you’ve hit an 80% LTV —either because you’ve paid down your debt or because your home has increased in value.
The process to request cancellation varies by lender, and they may make it difficult for you by requiring an appraisal and lots of documentation. But if you really want it removed, it should be possible for you to achieve it.