What is Private Mortgage Insurance?

For many homebuyers, saving up for a downpayment is one of the biggest hurdles standing between them and a new home. Historically, 20% has been held as the standard for a down payment, and it can take years to save up that amount of cash. But the good news is, it’s possible (and common!) to buy a home without putting 20% down. If homebuyers go this route, they’ll likely encounter something called private mortgage insurance, or PMI.

While it may just seem like an extra cost, PMI can help make homeownership possible for many buyers who might feel it’s out of their reach. Let’s dive into what PMI is, how it works, and how you can manage or even avoid it.

What is PMI?

PMI, or private mortgage insurance, is a type of insurance that protects lenders in case a borrower may not be able to make their mortgage payments. It is typically required when a homebuyer makes a down payment of less than 20% on their loan. PMI doesn’t protect the borrower—it’s designed to reduce risk for lenders, allowing them to offer loans with lower down payment requirements.

How Does PMI Work?

PMI is usually added to your monthly mortgage payment, though it can also be paid as a lump sum at closing or financed into the loan. The lender arranges PMI through a private insurance provider, and the borrower pays the premiums. PMI remains in place until you reach a specific equity threshold, at which point it can be removed.

Types of PMI

There are several different types of PMI, each with its own structure. Borrower-paid PMI (BPMI) is generally the most common type, but you may want to become familiar with the other types in case a different structure is better for your unique financial situation.

Borrower-paid PMI (BPMI): The most common form, BPMI is added to the borrower’s monthly mortgage payment. Once you reach 20% equity, you can request its removal.
Lender-paid PMI (LPMI): The lender pays the PMI premium upfront in exchange for a slightly higher mortgage interest rate. The benefit is a lower monthly payment, but LPMI cannot be canceled once enough equity is built.
Single-premium PMI: A one-time upfront payment at closing that avoids monthly PMI costs. This can be paid by the borrower, lender, or split between both.
Split-premium PMI: A hybrid approach where part of the PMI is paid upfront, reducing the monthly premium.

How is PMI Cost Determined?

The cost of PMI is based on several factors, including:

Loan-to-value (LTV) ratio: The LTV ratio compares your loan amount to your home’s value. The higher the LTV (meaning a lower down payment), the higher your PMI cost.
Loan amount: Larger loan amounts may result in higher PMI costs.
Type of loan and term: Adjustable-rate mortgages (ARMs) often have higher PMI costs than fixed-rate mortgages, and longer loan terms may also increase costs.

On average, PMI costs range from 0.5% to 2% of the loan balance per year, but can run as high as 6%.

PMI Example

Let’s say you buy a $250,000 home with a 10% down payment ($25,000). Your loan amount is $225,000, making your LTV ratio 90%. If your PMI rate is 0.5%, you’ll pay $1,125 per year (or about $93.75 per month) in PMI premiums.

How to Avoid PMI

Avoiding PMI usually requires a 20% down payment, but there are other strategies:

Consider a piggyback loan: Some buyers use an 80-10-10 loan structure, where they take out a second loan to cover part of the down payment.
Look for lender-paid PMI options: Some lenders offer LPMI, but be aware that this may mean a higher interest rate.
Explore loan programs without PMI: Government-backed loans like VA loans (for eligible veterans and service members) do not require PMI.

How to Get Rid of PMI

Once you’ve built enough equity, PMI can be removed:

Automatic termination: By law, lenders must cancel PMI once your loan balance reaches 78% of the home’s original value.
Borrower request: You can request PMI removal once your balance reaches 80% of the home’s original value, provided you have a good payment history.
New appraisal: If your home’s value has increased significantly, you may be able to refinance or request PMI cancellation based on a new appraisal.

Final Thoughts

Understanding PMI can help you make informed decisions when buying a home. While it may seem like an added expense, PMI can be a useful tool to help homebuyers enter the market sooner.

If you’re ready to explore your mortgage options, Ruoff Mortgage is here to help. Contact us today to learn more about your loan options and how to manage PMI effectively.