What is private mortgage insurance (PMI) & how does it work?

If you’ve ever considered buying a home, you might know that many mortgage lenders ask for an upfront deposit, or down payment, of up to 20% of your home’s cost. If that’s a barrier for a potential buyer, private mortgage insurance—PMI for short—can make homeownership more accessible. 

But what exactly is PMI? How does PMI work? And how much does it cost? Use this guide to learn more about PMI and how it may apply to you if you’re searching for a place to call your own.

Key takeaways

• Private mortgage insurance is a type of insurance policy arranged by a mortgage lender when a borrower puts down less than 20% on a home.
• PMI protects the lender should the borrower stop making payments. 
• The borrower can pay for PMI in monthly installments or as an upfront fee.
• PMI can be removed or terminated once a certain amount of equity has been reached.

PMI is a type of insurance policy you might need to secure a mortgage. This type of insurance policy is typically needed when the borrower puts down less than 20% of the home’s purchase price. 

PMI protects the lender if the borrower fails to make payments on the mortgage. It’s determined by the lender, and a private insurance company provides the policy. 

You might also need PMI if you’re refinancing a home with a conventional mortgage—a mortgage that’s not insured by a government agency—and have less than 20% equity in the property. Equity is the difference between the current market value of a residence and what’s owed on a mortgage. 

Why do you need PMI?

Private mortgage insurance provides a pathway to homeownership for people who don’t have the funds to put down 20% on a conventional loan. It can help borrowers qualify for a loan that they might not otherwise be able to get.

Putting down less than 20% on a property means the loan-to-value (LTV) ratio on the home is more than 80%. The higher the LTV, the more risk to the lender. The monthly PMI premium is additional money paid by the buyer to make up for the lender’s extra risk. It means the bank could get back some of the money it lent if the borrower were to default. 

In most cases, lenders require the borrower to pay PMI until there is enough equity in the home. 

How are PMI payments made?

There are different ways to pay for PMI. It’s often added as a monthly premium to your mortgage payment. Like property taxes or homeowners insurance, you can pay the PMI premium through an escrow account. The lender then issues the payment on your behalf.

You can also pay for PMI with an upfront lump sum at closing. Or you can do a combination of monthly payments and an upfront premium. You can contact your lender to discuss the options available to you. 

What does PMI cover?

PMI is an insurance policy that protects the lender, not the borrower. This means that a home can still be foreclosed on if payments were to stop being made on the property.

As a guide, credit-reporting company Experian estimates PMI costs 0.2%-2% of the original loan amount each year. But estimates of the percentage range vary slightly.

Remember, you can pay the PMI monthly or as an upfront premium, depending on the lender’s requirements and options. You can find the cost of a premium payment on your loan estimate and closing disclosure in the projected payments portion of your mortgage package. 

What factors impact the overall cost of PMI?

These are the two main factors that can influence the total PMI you may pay:

• Down payment: The more money you put down on the purchase price of a home, the closer you are to having 20% equity in the property and the lower your LTV ratio. This can result in a lower PMI arrangement. 
• Credit scores: The lender will factor in your credit scores when determining the PMI percentage. The better the credit score, the less you might pay in PMI.

You can remove PMI from most conventional mortgages once the equity threshold of 20% has been reached. There are a few different ways this can happen.

Requesting PMI cancellation

Under the Homeowners Protection Act (HPA), you can cancel your PMI when the principal balance of your mortgage falls to 80% of the original value of the home. That’s when you reach 20% equity in your home. You can find the date when you’re scheduled to reach 20% on the PMI disclosure in your closing paperwork. 

Your lender may have their own requirements, but here are a few conditions that must be satisfied when requesting PMI cancellation:

• The borrower must have a good payment history on the loan.
• The loan must be current.
• The request must be made in writing. 

Automatic or final PMI termination

Even if you don’t request it, the HPA requires the lender to automatically cancel the PMI when the principal balance of the mortgage reaches 78% of the original value of the home—in other words, when you reach 22% equity. This is known as automatic PMI termination.

The lender must also cancel the PMI once the borrower reaches the halfway point of the loan, whether or not they have reached 78% of the home’s original value. This is known as final PMI termination.

Both circumstances apply as long as you are in good standing and haven’t missed any payments.  

Early PMI cancellation

You should have an idea of when you can get rid of PMI if you meet your scheduled mortgage payments. Here are some ways you might be able to get rid of PMI sooner: 

• If you make additional mortgage payments. This will build your home equity faster, so you can get to the 20% threshold sooner. 
• If you reappraise your property. If you think the home’s market value has increased, you can get a home reappraisal. And if the new value brings your home equity up to 20%, you can request PMI cancellation.
• If you refinance your loan: If you’re refinancing to save on interest costs or to reduce your monthly payments and you find that your equity has increased by more than 20%, you might be able to get a new loan without PMI. 

Bear in mind that reappraisal and refinancing both have other costs and considerations associated with them. You can talk to your lender to find out if these options are right for you.

Mortgage insurance is different for government-backed mortgages like Federal Housing Association (FHA) loans. 

With an FHA loan, two types of mortgage insurance are added: an upfront mortgage insurance premium (UFMIP) and the annual mortgage insurance premium (MIP). 

According to the U.S. Department of Housing and Urban Development, UFMIP is 1.75% of the total amount of the loan. It can be paid for upfront at closing or rolled into the monthly mortgage payment. MIP is paid in monthly installments for the life of the loan. Its cost depends on the terms of the loan.

There are a few ways you can avoid paying PMI if you don’t have a 20% down payment. Comparing the costs of each can help you decide whether any of them is a good alternative for you.

Consider a VA or USDA loan

Certain government-backed programs don’t include PMI—or any type of mortgage insurance—in the loan package. You can check the requirements to see if you’re eligible.

A VA loan doesn’t require a down payment or mortgage insurance to secure it. It’s open to eligible veterans and active-duty service members or surviving spouses. 

A USDA loan provides mortgages to low-income to moderate-income families to purchase or build a residence in a rural area. Like VA loans, USDA loans don’t require a down payment or mortgage insurance during the length of the loan.

Research a piggyback second mortgage

If you have some money to put down on a home, a piggyback mortgage can help you avoid PMI. A piggyback mortgage is when you take out two loans on the same home at the same time. It’s typically done using an 80-10-10 configuration—so it’s also known as an 80-10-10 loan.

In that instance, the borrower may put 10% down, finance 80% of the main mortgage and take out a second loan worth 10% of the home’s value to “piggyback” off the second mortgage. The interest rate is typically higher on the second mortgage.

Examine lender-paid mortgage insurance

As the name suggests, lender-paid mortgage insurance (LPMI) is when the lender pays the PMI in exchange for a higher interest rate. 

Keep in mind that only some lenders offer this type of insurance. And LPMI can’t be removed once a certain equity threshold has been reached.

PMI is an additional monthly cost to your mortgage payment, but it can make homeownership more accessible. It can give you the opportunity to purchase a home quicker than it might take to save a 20% down payment, allowing you to begin building equity. 

If you plan on putting down less than 20% on a home, remember to account for PMI in your housing budget. Having a general idea of how PMI works and planning for this expense puts you one step ahead in the home buying process.