What Is Private Mortgage Insurance (PMI) and When is PMI Required?

Buying a home is one of the largest purchases you’ll make in your life, and you probably aren’t paying for it with cash. People often pay for their home with a down payment and a loan. A down payment is the initial amount of money you contribute towards your home. A loan, or mortgage, is the money you borrow from a bank or lender to cover the rest of the cost, but it is expected that the sum of money you borrowed will be paid back with interest. If you pay a low down payment on your home, your lender may require you to have private mortgage insurance (PMI).

For example, if you buy a home that costs $350,000, the down payment may be $35,000, which is 10% of the total cost. You would have to take out a loan for the remaining $315,000. In that case, most lenders will require PMI.

What Is PMI?

Private mortgage insurance is a form of insurance that protects the lender if you don’t pay your mortgage. Your lender is taking on a lot of risk with your home loan. In our example, the lender is responsible for 90% of the cost of your home. If you don’t pay your mortgage every month, which is called defaulting on your loan, the lender is responsible for the bill. 

It’s not easy for a lender to get their money back if you default on the loan. A lot of work is involved, and your home might not be worth as much as it was when you bought it. Lenders usually expect to lose about 20% of the purchase price if you don’t repay your loan, so PMI protects their part of the investment.

When Is PMI Required?

With conventional home loans, lenders typically require PMI if your down payment is 20% of the home’s value or less. When you put a smaller amount of your money at risk, you’re statistically more likely to default on the loan.

How Much Does PMI Cost?

The cost of your PMI will vary based on the insurance company that your lender chooses. It’s calculated based on the amount of your loan, typically from 0.5 to 1.5% of the loan amount per year.

Referencing the same example used above, you would have to pay $1,575 to $4,725 per year, or $131 to $394 per month, for PMI. Your PMI payments are typically added to your mortgage payments along with your property taxes and homeowner’s insurance payments. 

Your PMI is recalculated yearly, so it will go down every year as you pay off your loan balance.

How Long Do I Have to Pay PMI?

PMI could potentially cost you a lot of money, so you don’t want to pay it if it’s not necessary. Once you’ve paid your mortgage to a certain point, you can remove PMI from your loan. (The rules are different if you bought your home before July 1999.)

You can ask your lender to cancel PMI when the balance on your mortgage is 80% of the value of your home or less, as long as you have been paying your mortgage on time and don’t have any second mortgages or other liens on your home. So, in our example, when your mortgage balance falls below $280,000 you can request that your bank remove the PMI.

You may need to provide evidence that your balance is 80% of the value of your home or less. To do this, your home may need to be appraised, which could cost you $300 to $800, depending on your home’s size and where you live. 

If you don’t ask your bank to cancel PMI, it can still be canceled automatically. This usually happens when you’ve been paying your mortgage on time and:

• Your loan balance is 78% of your home’s value or less.
• You reach the midpoint of your loan’s term. If you have a 30-year mortgage, the midpoint would be 15 years.

Are There Alternatives to Paying PMI?

There may be alternatives for you if you don’t want to pay PMI. Here are some options to consider. 

Paying a Higher Interest Rate

You can ask your lender if they would increase your interest rate instead of requiring PMI. Generally, the higher interest rate will mean your monthly mortgage payments are about the same as they would be with PMI. 

• Pros: The interest will be paid toward your mortgage balance, so you’ll pay off your mortgage quicker and save on interest in the long run. It’s also possible that you can deduct the interest you’re paying from your taxes.
• Cons:  You can’t remove the higher interest rate once you reach a certain amount of equity. You will have to pay it for as long as you have the loan.

Piggyback Financing (80-10-10 Financing)

An alternative to paying PMI is 80-10-10 financing, or piggyback financing. In this case, a lender provides 80% first mortgage. Then you obtain a 10% second mortgage and make a 10% down payment. 

You can adjust this type of financing to accommodate the size of your down payment. For example, you could put 7% down and have 80-13-7 financing. Keep in mind that the lower your down payment is, the higher your interest rate and fees will be. 

• Pros: You can usually deduct the interest on the loans from your taxes. 
• Cons: This type of financing may cost more than your potential PMI payments, especially if your down payment is less than 10%.

Protect Your Investment

Your new home is a significant investment, and you want to make sure it’s protected. Reach out to a Farm Bureau agent to ensure that your coverage fits your needs.