Private Mortgage Insurance: Getting To Know The Basics

Key Takeaways

  • Private mortgage insurance (PMI) is a premium paid by homeowners who pay less than 20 percent down at signing.
  • The only way to avoid PMI outright is to make a 20 percent down payment, but there are some ways to get out of it early.
  • Homebuyers should make sure to understand the financial impact PMI can have on their monthly payments when opting to make a down payment of less than 20 percent.

When a consumer purchases a home for the very first time, they may be unaware that private mortgage insurance can be added on to their monthly mortgage payments if they make a down payment of less than 20 percent. Read on to find out the definition of private mortgage insurance (PMI), how it works, and how to avoid it.

What Is Private Mortgage Insurance?

Private mortgage insurance protects the lender in the case a homeowner fails to make mortgage payments. Provided by private mortgage insurance companies, home buyers will often be required to pay private mortgage insurance if they make a down payment of less than 20 percent when purchasing a property. PMI may also be required when refinancing, when the equity is less than 20 percent of the property value. Lenders will most often require a monthly premium that is added on to the monthly mortgage payment, although some lenders may require a one-time premium to be paid at the closing of the purchase.

Having the option to pay private mortgage insurance can be a savior for consumers who cannot afford to make a 20 percent down payment. Especially in markets where purchase prices are high, along with high cost of living, a 20 percent down payment can be prohibitive for many. However, opting for the short-term satisfaction of purchasing a property with a lower down payment can lead to long-term costs. Below are several potential downsides to PMI that home buyers should consider:

  • Adds to your costs: Mortgage insurance typically costs between 0.5% to 1% of the mortgage loan amount, which can significantly increase your monthly payments. For example, for a home with a purchase price of $300,000, homeowners may have to spend an additional $3,000 per year on insurance, which comes out to roughly $250 per month.

  • Does not benefit you: When consumers hear the word “insurance,” they may assume the premium in some way helps to protect them, or that there may be an opportunity for compensation. When it comes to mortgage insurance, this is not the case. PMI is paid solely to benefit and protect the lending institution.

  • Giving money away: Homeowners who opt to put down less than 20 percent on a home purchase will be required to pay PMI until the equity in the property reaches twenty percent. Although the home buyer may feel like they are saving some money by putting down a smaller down payment, there could be a larger opportunity cost associated with paying an expensive monthly premium. In addition, this can heavily impact a consumer’s monthly cash flow.

  • Difficult to cancel: Although homeowners are technically qualified to end their PMI payments once the home equity reaches 20 percent, the actual process of cancellation approval can be quite challenging. The lender may require a formal request letter to be submitted, as well as a formal appraisal, which could take several months to process and approve. In addition, some lender may include a minimum time period in the PMI contract. While homeowners wait to reach these requirements and have their insurance requirement to officially be canceled, they will usually be obligated to continue making payments.


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Private Mortgage Insurance Calculator

Now that you have become more familiar with some of the advantages and disadvantages to paying PMI, you may be wondering how to calculate private mortgage insurance. Rates vary depending on the mortgage lender, but private mortgage insurance rates typically range between 0.5% to 1% of the purchase price. However, other indicators such as the loan term, interest rate, and credit rating can be factored into the calculation. Many websites such as HSH.com provides consumers with a free and easy-to-use private mortgage insurance calculator, so that you won’t have to figure out your potential monthly payments on your own.

What Does Private Mortgage Insurance Cover?

Private mortgage insurance covers the lending institution when a homeowner defaults on their mortgage loan payments. When a home buyer makes a down payment of less than 20 percent, the principal amount on the loan is greater, thus increasing the risk taken on by the lender. Because of this, an insurance premium is assessed to the home buyer to help the lender recover costs if the buyer defaults on their loan.

Average Private Mortgage Insurance Rates & Costs

A typical private mortgage insurance rate can range between 0.5% to 1% of the total purchase price of a home, assessed annually. The cost of private mortgage insurance is based primarily upon the total purchase price of a home. According to Zillow.com, the current median home value in the United States is $207,600. This means that the annual premium could cost a home buyer roughly $2,076, if calculated at the higher range of 1 percent. When home buyers wonder, “how much does private mortgage insurance cost,” most likely they would like to know the monthly payment that will be added on to their monthly mortgage payment. In this case, simply divide the annual premium by twelve. Continuing on with the example, an annual premium of $2,076 would equate to roughly $173 in monthly payments. Again, it is important to note that this cost is in addition to the monthly mortgage payment.

How To Get Rid Of Private Mortgage Insurance

Homeowners must have paid a down payment of 20 percent of a property’s total purchase price in order to completely get rid of private mortgage insurance. Understandably, making such a large equity payment is not a possibility for many home buyers. In this case, the priority shifts to getting rid of PMI as soon as possible. Homeowners can begin to negotiate with their lender to cancel their PMI once the property equity reaches 20 percent, or the mortgage balance drops below 80 percent of the property’s appraised value. Below are some tips to shortening the timeline as much as possible:

  • Pay down your principal: The most direct method of gaining a 20 percent equity in your property is to pay down your outstanding principal as quickly as possible. A prepayment of even the slightest amount each month can help you in the long run.

  • Refinance your property: Market conditions will often cause property values to increase or decrease over time. In favorable conditions, property values may have increased enough, such that a homeowner can choose to refinance their property with a new lender that will not require mortgage insurance.

  • Invest in a remodel: A creative way to increase property value is to add features, such as an additional room or swimming pool, such that your loan-to-value ratio will change. When a homeowner invests in a remodel, they should make sure to ask their lender to recalculate their PMI requirement.

  • Re-appraise your property: In some cases, lenders will accept a new appraisal after some time has passed. However, home appraisals cost several hundred dollars, so homeowners should make sure in advance that the lender would accept a new appraisal value in consideration for canceling PMI.

Although the rule of thumb for down payments has remained 20 percent for several generations, home buyers are increasingly purchasing homes with smaller down payments. Accordingly, many American homeowners are paying private mortgage insurance premiums each month. Paying less than 20 percent for a property down payment may help some home buyers achieve their dreams of homeownership, but they should make sure to familiarize themselves with the impact PMI can have on their finances in the long-run.

How do you weigh in on the advantages and disadvantages of opting to pay private mortgage insurance instead of making a 20 percent down payment? Feel free to join the conversation below:

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