The Ins and Outs of Private Mortgage Insurance

The home buying process is dizzying. Between all the closing costs and other fees, many first-time buyers don't expect the overwhelming number of seemingly random expenses. However, private mortgage insurance—also known as PMI—is one cost that should be on your radar if you are buying a home.

Private mortgage insurance is typically required if you don’t have enough money to cover a standard 20% down payment when buying a home.

While the buyer is responsible for paying for PMI, the lender is the only beneficiary. Mortgage insurance exists to protect a lender if you default on your mortgage payments and go into foreclosure.

PMI can be costly, but it’s important to know that you won’t have to pay it forever. We will explore precisely how PMI works, how much it costs, and how you can get rid of it.

The one thing you have to remember is that PMI can help you buy a home more quickly if you don't have enough money saved for a 20% down payment!

How Much Does PMI Cost?

Private mortgage insurance typically costs between 0.5% to 1.5% of the entire loan amount. However, the cost is recalculated annually to account for any mortgage payments made, so your PMI will get less expensive every year.

The cost of PMI is determined based on your credit score, loan term, and down payment.

Your monthly PMI fee is calculated by taking the annual PMI cost (denoted as a %) and multiplying it by your total loan amount and dividing by 12. This amount is usually added to your monthly mortgage payment.

For example, if your mortgage is $300,000 and your annual PMI cost is 1%, your PMI would cost $3,000 annually, or $250 on a monthly basis.

Paying for PMI is frustrating because you won't benefit from it if you can't keep up with mortgage payments. However, it can still be a tremendous asset because it's giving you the ability to buy a home earlier.

How and When Is Mortgage Insurance Paid?

For conventional loans, PMI is typically paid as a monthly premium that's included in your regular mortgage payment. However, some mortgages may require a fee to be paid upfront.

Different mortgage types and lenders will handle it differently, and they'll explain it as you move through the lending process.

Once you've made enough payments to lower the mortgage balance to 78% of the home's value, the mortgage servicer must eliminate PMI. Some buyers will contact their lender in writing to ask them to remove the PMI once the remaining mortgage balance drops to 80% of the home value, in accordance with only needing PMI below the 20% down payment threshold.

Why Do I Need to Pay for PMI If Lenders Keep the House If I Default?

If you think that your house should be enough collateral in exchange for a loan, you aren't alone. Unfortunately, mortgage lenders don't view it the same way.

The reason PMI is only required below the 20% down payment threshold is that lenders assume that they will only get 80% of the value of the home when they take possession and sell it to another buyer. Additionally, lenders may view buyers who can't cover a standard down payment as riskier since those buyers have less money on the line if stop making payments and walk away from the home.

If your home goes into foreclosure the lender will file a PMI insurance claim to protect themselves financially.

The Benefits of PMI

You won't find many people touting the benefits of PMI, but in reality, it can be an extremely valuable tool. If you've been dreaming of finally owning a home and building equity, PMI can give you the ability to realize your dreams several years earlier.

From a lifestyle perspective, the benefits of buying a home are pretty clear. Many people want the stability of a fixed mortgage payment without having to worry about their landlord increasing their rent or kicking them out. But PMI can also pay off from a financial perspective. PMI typically costs between 0.5% to 1.5% of your home value, which means that if your home appreciates more quickly than the cost of the PMI, you'll be making a wise financial decision.

Additionally, you might live in an area where renting is more costly than owning a home, so PMI could even allow you to lower your living expenses. This can be true in large metropolitan areas where young professionals drive up the demand for apartment rentals and force rental rates to increase.

If you want to buy a home for personal or financial reasons, but can't afford to put 20% down or simply want to keep some of your cash on hand in case of an emergency, PMI can make it possible for you to buy a home!