What is Private Mortgage Insurance?
Private mortgage insurance, PMI, is a type of mortgage insurance that is required when you obtain a conventional loan and make a down payment of less than 20 percent of the home’s purchase price. If you’re refinancing with a conventional loan and your equity is less than 20 percent of the value of your home, PMI is also required.
If you offer a down payment between 3 percent and 19.99 percent, your lender sees you as a higher risk. Historically, a significant percentage of borrowers who have defaulted (stop paying) on their mortgages made less than a 20 percent down payment.
PMI helps protect the lender if you suddenly lose your job or other unforeseen issues arise where you can’t make your mortgage payments. In this scenario, the private mortgage insurance will cover a percentage of the lender’s loss.
The primary benefit of PMI to the borrower is that it can help you qualify for a loan that you might not otherwise be able to get. On the downside, PMI will increase the cost of your loan. It also does not protect you if you run into problems with your mortgage – it only protects the lender.
HOW MUCH DOES PMI cost YOU?
How much you need to pay for PMI is dependent on several factors:
- Your down payment. Your lender may charge PMI if your down payment is lower than 20%. The lower your down payment, the higher risk you are to lenders.
- Your credit score. This number indicates to lenders how responsible you are when you borrow money. A lower score indicates that you may be more likely to default on your loan. As a result, you’ll pay more in PMI.
- Your property type.
- Your debt-to-income ratio.
- Your home value.
As a general rule, you can expect to pay anywhere from 0.25% to 2.00% of your loan balance per year. PMI is arranged by the lender and provided by private insurance companies.
With the average U.S. mortgage around $200,000, this means your PMI costs can range from $500 to $4,000 annually, on top of your mortgage, homeowner’s insurance, and other homeownership costs.
HOW DO I PAY FOR PMI?
There are several ways to pay for PMI. Ask your lender what choices they offer.
- Monthly Premium. The most common way to pay for PMI is a monthly premium. The premium is added to your mortgage payment. The premium will be shown on your Loan Estimate and Closing Disclosure. You will receive a Loan Estimate when you apply for a mortgage, before you agree to the mortgage.
- One-Time, Up-front Premium Paid at Closing. If you make an up-front payment and then move or refinance, you may not be entitled to a refund of the premium.
- Pay a combination of both up-front and monthly premiums.
- Paying a higher interest rate on your loan and avoiding mortgage insurance premiums completely, known as Lender Paid Mortgage Insurance (LPMI), is another option many buyers consider. Even though the hunt for the lowest interest rate is paramount to borrowers – this is one time it might not be in your best interest. Borrowers who elect LPMI will pay approximately one-quarter percent higher interest rate, and the lender will pay the mortgage insurance premium. There are tax advantages to this option, however, it means you won’t ever get rid of the burden of PMI.
- Another way to avoid paying PMI is to structure your mortgage into two loans. How does that work? Commonly known as Piggyback loans, they are typically the first mortgage of 75-80% loan-to-value plus a second mortgage for 10-15% loan-to-value, giving a combined loan-to-value of no higher than 90%. The second mortgage is usually a Home Equity Line of Credit (HELOC) with a variable interest rate.
ARE THERE ALTERNATIVES TO A LOAN THAT REQUIRES PMI?
Lenders will sometimes offer conventional loans with smaller down payments that do not require PMI. However, you will pay a higher interest rate for these loans. Paying a higher interest rate can be more or less expensive than PMI; it depends on a several factors, including how long you plan to stay in the home.
Borrowers making a low down payment may also want to consider other types of loans. Other loan types may be more or less expensive than a conventional loan with PMI, depending on your credit score, down payment amount, lender, and market conditions.
One of the best alternatives to PMI is saving up the money to make a 20 percent down payment. When you pay 20 percent down, PMI is not required with a conventional loan. You may also receive a lower interest rate with a 20 percent down payment.
Speak to your lender about detailed loan options to determine the best deal for you.
DOES PRIVATE MORTGAGE INSURANCE HAVE ANY TAX BENEFITS?
The ability to write off private mortgage insurance premiums is dependent on the current tax law and the will of Congress. The Consolidated Appropriations Act of 2020 extended the PMI deduction into 2020 and 2021. There is no word yet on what will happen to deductibility in 2022 or beyond. Being able to deduct mortgage insurance premiums in future years is uncertain as it was going to be abolished year ago, but Congress keeps renewing it on a year-by-year basis.
According to IRS Publication 936, “You can treat amounts you paid during 2021 for qualified mortgage insurance as home mortgage interest. The insurance must be in connection with home acquisition debit, and the insurance contract must have been issued after 2006.” That means you can deduct mortgage insurance paid throughout 2021, but only if the loan was used to purchase your home.
There is an income cap. The deduction is subject to qualified taxpayer’s adjusted gross income (AGI) limits and begins phasing out at $100,000 and ends at those with an AGI of $109,000 (regardless of filing status). To take the mortgage insurance deduction, you must itemize deductions on your tax return.
The deduction applies to premiums on mortgage insurance provided by the Department of Veterans Affairs, the Federal Housing Administration, the Rural Housing Service, and private insurers.
WHEN AND HOW TO GET RID OF PMI
You will pay monthly PMI until you have accumulated enough equity in your home.
Once you reach 80 percent loan-to-value (LTV), you can call your lender and ask them to eliminate your PMI. If you reach 78 percent, your lender is required to cancel PMI on your behalf – as long as you are current on all your payments.
- credit report
- first-time homebuyer
- home buying
- mortgage loan
- private mortgage insurance