Private mortgage insurance can help you qualify for a loan you may not have otherwise been able to get. But beware of the pitfalls.
If you’re thinking about buying a home, you might have heard about private mortgage insurance, or PMI. It’s an additional fee on top of your principal and interest, escrow, and taxes that protects the lender in case you default on the loan.
PMI, which is used with conventional loans, is arranged by the lender and provided by mortgage insurance companies. It can help you qualify for a loan you may not have otherwise been able to get.
PMI is required on a conventional loan if you put down less than 20% of the loan amount. That’s because it’s been shown that homebuyers who put down less than that amount are more likely to go into default. It’s also required if you’re refinancing with a conventional loan and your equity is less than 20% of your home’s value.
But there are downsides. You could wind up paying as much as $50 to several hundred bucks extra a month for PMI, depending on your loan amount. And it’s money you’ll never see again. It doesn’t lower your loan balance and it’s not tax-deductible like your mortgage interest.
It can also be hard to get rid of, even after you owe less than 80% of the home’s worth. PMI is supposed to be removed at that point, at least in theory. But removing PMI isn’t automatic. You may need to ask that it be removed from your monthly mortgage payment. Some lenders also require homeowners to provide documents and get a formal home appraisal before they’ll remove PMI. If your payments are up to date, once you’ve reached 78% of the loan amount, your lender must cancel your PMI.
The easiest away to avoid paying private mortgage insurance is to put down at least 20% when taking out a home loan. That means you’ll save money over the life of your loan: By borrowing less money, you’ll be paying less in interest. Another bonus? You’ll have more equity in your home right away.
You can also explore different types of low-down-payment loans to avoid paying PMI. U.S. government–backed loans including Veterans Affairs (VA) loans and Federal Housing Administration (FHA) loans don’t require PMI. But there’s still an insurance fee when taking out an FHA loan, which does not come cheap: The fee currently costs borrowers 1.75% of the loan amount upfront with an ongoing monthly fee of 0.85% for a mortgage of 15 years or more, with a loan-to-value ratio of more than 95.01%. VA loans also include a funding fee and other costs.