Understanding PMI: What is private mortgage insurance?

The total cost of financing a home purchase takes some borrowers by surprise. If you apply for a conventional loan and put less than 20% down, you’ll usually have to pay for private mortgage insurance (PMI) — a likelihood for many buyers, considering the average down payment is about 13.6%, according to REALTOR.com. Fortunately, there are ways you can minimize or eliminate PMI, if your lender requires it. Understanding mortgages and their associated costs can help you budget for your home purchase and maybe find ways to save. 

What exactly is PMI?

Private mortgage insurance is an insurance policy that covers your lender’s losses if you stop paying your mortgage loan. Lenders require this type of coverage when a borrower finances a home with a conventional loan and makes a down payment of less than 20% of the sale price. Buyers who invest less cash in their home purchase are more likely to default on their mortgage so the insurance protects the lender if that happens.

Your lender will purchase the policy from a private insurance company before you close on the loan, but you’ll pay the premium on the lender’s behalf. Lenders usually have homeowners pay the premium monthly, as part of their mortgage payment, but they might charge some or all of the premium at closing.

How is it calculated?

A PMI rate is a percentage of the loan amount, and it can vary according to your down payment amount, credit score, debt-to-income ratio, loan-to-value ratio (LTV), loan term, whether your mortgage rate is fixed or adjustable, and the amount of coverage the PMI provides for the lender. In 2023, the Urban Institute reported that borrowers paid mortgage premiums between 0.19% and 1.86% of the loan amount. The lender would divide that amount by 12 and add 1/12 to each mortgage payment.

For example, say you purchase a $400,000 home with 5% ($20,000) down, leaving 95%, or $380,000, to finance.

With a 720 credit score and 5% down payment, you might pay a PMI rate of 0.6% on a $380,000 loan. Multiply $380,000 by 0.6% to get the annual premium, which is $2,280. That amount divided by 12 is $190. The lender would add $190 to each monthly mortgage payment to cover the annual premium.

If, on the other hand, you put 15% down ($60,000), the total to finance is $340,000. A smaller LTV means your PMI rate might be just 0.06% — one-tenth the amount you’d pay with the 5% down payment. Here your annual premium is $204, which adds just $17 per month to your mortgage payment. 

Can you avoid paying PMI?

PMI increases your mortgage payments, which can make your loan harder to qualify for and make it harder to pay if you do qualify. It’s usually mandatory with an LTV of 80% or more, but you do have a few ways to avoid it:

• Make a larger down payment: The best way to avoid PMI is to put more money down, even if it means delaying your home purchase while you save the extra cash. If you’re eligible, consider applying for down payment assistance for first-time homebuyers. Paying at least 20% down has benefits beyond avoiding PMI, such as possibly getting a lower interest rate and providing an equity cushion in case property values fall and you want or need to sell. 
• Negotiate lender-paid mortgage insurance: Sometimes the lender is willing to pay for the PMI in exchange for charging you a fee at closing or increasing your interest rate to cover the cost. Think carefully before accepting this arrangement. You might be better off applying an upfront payment to your down payment instead. A higher interest rate might be more expensive than PMI in the long run because it lasts the entire loan term, whereas you’ll be able to cancel PMI at some point. 
• Consider a different loan type: You don’t have to pay mortgage insurance on loans backed by Veterans Affairs or the U.S. Department of Agriculture, even if you put zero down. Both loan types have eligibility criteria you’ll need to meet, and each has an upfront fee due at closing — USDA loans have a guarantee fee and VA loans have a funding fee up to 3.3% of the loan amount. Either one could save you money if the alternative is paying PMI. 
• Look for special mortgage programs with no PMI: Check to see if your state offers no-PMI loans for first-time homebuyers or borrowers with modest income. Some lenders have special programs of their own. Citi’s HomeRun mortgage is one example. It lets you buy with just 3% down and no PMI requirement.

Can I cancel PMI?

PMI is only a requirement if you pay less than 20% down on your home. Once you reach 20% equity, you can ask the lender to cancel the insurance if you meet the following requirements:

• No 30-day-late payments in the last year, and no 60-day-late payments in the last two years
• Property value is the same or higher than when purchased or originally appraised (may require a new appraisal)
• No second mortgage or other junior lien on property

If you ask to have the PMI canceled based on the home’s increased value, your LTV ratio must be at least 75% if your loan is two to five years old or at least 80% if your loan is more than five years old according to Freddie Mac. You can request it when you reach 80% if you’ve had the loan for five or more years.

Even if you take no action to cancel your PMI, your lender or loan servicer must cancel it once your LTV reaches 78%, or you reach the halfway point in your loan term, as long as your payments are up-to-date.

What are the payment options?

Most lenders break down the annual premium into monthly payments that borrowers pay as part of their mortgage. There’s no guarantee that a particular lender will allow a different payment structure, but if yours does, it could be one of the following:

• Upfront payment at closing: You might be able to make a single payment at closing. Before you do, ask your loan officer to calculate how much the PMI would be if you used the money to make a larger down payment instead.
• Combination upfront and monthly payments: The lender might allow you to pay part of the premium as an upfront payment at closing and pay the rest with your monthly mortgage payments. The benefit is that the upfront premium payment will reduce your monthly payments.

PMI vs MIP: What's the difference?

The primary difference between PMI and mortgage insurance premiums (MIP) is that private lenders require PMI premiums for conventional loans, and the Federal Housing Administration requires MIP for FHA loans. Here’s how the two compare:

How does it impact your mortgage payment?

Monthly PMI payments increase your mortgage payments, which makes less of your cash available for other uses. How much it adds depends on your PMI rate, your loan amount, and how long you pay, but even a low rate adds up to a lot of money over time.

Take, for example, the amounts you get if you use $400,000 as a purchase price, a 30-year loan term and 7% as the mortgage interest rate in Freddie Mac’s PMI calculator. With a 10% down payment, the mortgage payment is $2,629, $234 of which is PMI. 

A $234 monthly PMI premium equals $2,808 per year. Over 15 years, the PMI payments would total $42,120. 

Running your own figures through a calculator will help you estimate your mortgage payments under different scenarios so you can make informed decisions about the best uses for your available cash when buying your home.

Private mortgage insurance FAQ

Is paying PMI mandatory?

PMI is typically required if you finance a home purchase with a conventional mortgage loan and a down payment of less than 20%. 

Does PMI differ from other types of mortgage insurance?

Yes. It’s structured differently than the MIP that FHA loan borrowers pay, and unlike mortgage protection insurance, which is a type of life insurance, PMI protects the lender.

What conditions warrant PMI removal?

You can ask the lender to remove PMI once you have 20% equity. The lender will remove it automatically when you have 22% equity or are halfway through your loan term.

What are the benefits and drawbacks of PMI?

The benefit of PMI is that it allows you to buy a home sooner than you could buy if you had to save 20% to put down. The drawbacks are that it’s expensive, and it only protects the lender.

How do loan types affect PMI requirements?

PMI is only for conventional mortgage loans. Other loan types have government backing that protects lenders and their own fees. FHA loans require mortgage insurance for at least 11 years, while USDA loans have an annual guarantee fee, and VA loans have an upfront funding fee.