Private mortgage insurance, or PMI, is often bad-mouthed as a terrible deal for consumers.
But without PMI, you might not be able to get a conventional home loan at all.
PMI is required on almost any conventional mortgage when the borrower doesn't make a 20% down payment.
And if you need to pay PMI, you’re in good company. About 25% of loans that closed at the end of last year required it. The younger you are, the more likely you'll need to pay PMI since you haven't had as much time to save.
Thanks to new lending guidelines enacted last December, you can put down as little as 3% these days, not 5%, and still get a conventional mortgage.
Other low-down-payment borrowers probably have just one other option: an FHA loan. The FHA lowered its mortgage insurance premiums in January from 1.35% of the monthly loan balance to 0.85% of the monthly loan balance, but you’ll still be stuck with FHA insurance for the life of the loan, whereas PMI eventually goes away.
Most borrowers will pay less with conventional PMI, but it depends on your down payment, credit score, loan term. Ask your lender to show you all your options. For higher-risk borrowers, the comparisons might look like those in the chart below.
Will you pay less with conventional or FHA?
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3% down, $200,000 loan and 680 credit score |
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Conventional Loan with Private Mortgage Insurance*
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FHA Loan with FHA Mortgage Insurance
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Upfront mortgage insurance %
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0.00%
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1.75%
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Upfront mortgage insurance amount
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$0.00
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$3,500.00
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Total loan amount**
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$200,000.00
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$203,500.00
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Monthly PMI %
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1.31%
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0.85%
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Monthly PMI amount
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$218.33
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$144.15
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5% down, $200,000 loan and 680 credit score |
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Conventional Loan with Private Mortgage Insurance*
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FHA Loan with FHA Mortgage Insurance
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Upfront mortgage insurance %
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0.00%
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1.75%
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Upfront mortgage insurance amount
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$0.00
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$3,500.00
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Total loan amount
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$200,000.00
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$203,500.00
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Monthly PMI %
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0.89%
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0.85%
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Monthly PMI amount
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$148.33
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$144.15
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Most borrowers roll the FHA’s up-front mortgage insurance into the loan balance.
Lenders look at your down payment, credit score and loan to get a number that they multiply against the amount you’re borrowing. The result is the annual cost of PMI. Divide that amount by 12 to get your monthly PMI payment.
The higher the loan amount and the lower your credit score, the higher the monthly PMI you pay; the closer you get to 20% down and excellent credit, the lower the monthly PMI.
There are several different companies that sell PMI, but their rates are similar, and you won't be able to choose, anyway. If your lender requires PMI, expect to pay monthly premiums for at least two years. At that point, you can cancel PMI if your home has appreciated enough or you've somehow prepaid enough principal to get to 25% equity.
Otherwise, you’ll have to pay PMI for at least five years and get to 20% equity, or 80% loan to value.
Canceling PMI costs money, too, because requires an appraisal to prove that your home is worth what you say it is. An appraisal might cost you $400 to $500. But don't order the appraisal yourself; your lender must order it directly or you won't be able to use it.
Market appreciation, improvements you’ve made or both could increase your equity quickly. Making extra principal payments is another way to reach the required 80% LTV.
How long will it take you to reach 80% loan-to-value just by making your scheduled monthly payments? Say you're borrowing $100,000 for 30 years at 4%, and your home’s purchase price was $110,000. When your loan closes, you’ll have 9% equity ($10,000 down payment divided by $110,000 purchase price). You’ll have 80% LTV when your loan balance is $88,000 (80% of $110,000).
Here's how to do the math. After plugging the loan amount, interest rate and term into a mortgage calculator, click on the amortization table tab and select the monthly option.
Scroll down until the number in the right column is $87,930 (the first point at which the balance drops below $88,000). Then look at the date in the far left column. In this example, it’s about six years into your mortgage. That's when you can contact your lender about canceling PMI.
(Also, when you sign your mortgage papers at closing, you should have received a disclosure notice providing the date when your loan is scheduled to reach 80% LTV.)
The good news is that federal law requires your lender to cancel PMI once you've paid your loan down to 78% of your home's purchase price, even if your home has lost value. No appraisal is required.
Waiting until you reach 78% means paying an extra year’s worth of PMI in this above example, however. Why not save your money by getting PMI canceled as soon as possible? The interest you'll save is probably more than the appraisal will cost. (You won't come out ahead, though, if your home appraises too low for you to cancel PMI.)
Contact your lender before you reach the 80% mark to ask what the official process is for canceling PMI so you’ll be prepared to ditch it. When you reach 80% LTV, submit your cancellation request in writing, making sure to carefully follow the lender’s requirements.
PMI cancellation, whether you’re at 80% or 78% LTV, is contingent upon your being current on the mortgage and having a timely repayment history. If you’re behind, you’ll have to catch up before your lender will cancel PMI.
To learn more about how much PMI costs, who it really protects and more, see my Interest.com article, "What you need to know about private mortgage insurance." I've also written