Buying a home is a major milestone, but for many first-time buyers - or anyone putting less than a 20% down payment - it comes with a few important considerations. One of the most common unexpected costs is private mortgage insurance, often referred to as PMI. Understanding PMI--why it exists, and how it affects your mortgage payments-- can help you make smarter choices when financing your home.
What is PMI?
Private mortgage insurance, or PMI, is a type of insurance that protects the lender, not the borrower. Essentially, it provides security for the lender in case the borrower is unable to repay the mortgage. PMI typically takes effect when a homebuyer makes a down payment of less than 20% of the home's purchase price.
Even though the borrower pays for it, PMI does not directly benefit the homeowner. Instead, it reduces the lender’s risk, making it possible for buyers to secure a loan with a smaller down payment. While it’s an extra cost, PMI can be a helpful tool for buying a house sooner rather than waiting to save for a larger down payment.
Why is PMI Required?
Lenders require PMI when they perceive a higher risk in the loan. A smaller down payment means the borrower has less equity in the home, which increases the likelihood of default from the lender’s perspective. By requiring PMI, lenders can offer mortgages to buyers who might not have a full 20% down, while protecting themselves financially.
PMI essentially acts as a safety net for the lender. Without it, many buyers who can’t afford a large down payment might be locked out of homeownership. By spreading the risk, PMI helps create access to the housing market while keeping loans safer for lenders.
How Does PMI Work?
PMI payments can vary depending on several factors, including the loan amount, the borrower’s credit score, and the type of mortgage. The cost generally ranges from 0.3% to 1.5% of the original loan amount annually. The higher the perceived risk (for example, lower credit scores or smaller down payments), the higher the PMI premium.
How PMI is Paid
There are a few ways to pay PMI:
- Monthly: Most borrowers pay PMI as part of their monthly mortgage payment. This method spreads the cost over the life of the insurance and keeps it predictable.
- Upfront: Some lenders allow borrowers to pay PMI in a lump sum at closing. This reduces monthly mortgage payments but requires extra funds at the start.
- Split-Premium: This approach combines a smaller upfront payment with a monthly PMI fee. It can offer a balance between reducing monthly payments and minimizing the upfront cash needed.
Example of PMI Costs
Let's say you're planning on purchasing a $350,000 home with a 10% down payment ($35,000). With a PMI rate of 1% annually, your monthly PMI would be approximately $262.50. This amount is added to your monthly mortgage payment for principal, interest, property taxes, and homeowners' insurance.
Types of PMI
- Borrower-Paid PMI (BPMI): This is the most common type. You pay monthly premiums directly, and you can request cancellation once you reach 20% equity in your home.
- Lender-Paid PMI (LPMI): The lender covers the PMI premium, but this is factored into a higher interest rate on your mortgage. While it may lower monthly payments in the short term, the higher interest can cost more over the life of the loan.
- Single-Premium PMI: Paid in one lump sum at closing or financed into the loan balance. This reduces monthly payments but requires upfront cash.
- Split-Premium PMI: Combines an upfront payment with ongoing monthly premiums. It’s a hybrid that can help reduce monthly costs while keeping upfront funds manageable.
What Does PMI Cover?
It’s important to note that PMI does not protect you or your home. Unlike homeowners' insurance, PMI does not cover damage, theft, or liability. Instead, it protects the lender if you default on the loan. In the event of foreclosure, the PMI insurer reimburses the lender for part of the loss, reducing the financial risk associated with lending on a property with lower borrower equity.
When Does PMI Go Away?
The good news is that PMI is not permanent. Federal law and lender policies set guidelines for cancellation.
- Automatic Cancellation: Lenders must automatically terminate PMI when your loan balance reaches 78% of the home’s original value, provided your payments are current.
- Request Cancellation: You can request PMI removal once you reach 20% equity, which might happen faster than scheduled if your home appreciates in value or you make extra payments. Most lenders will require a formal request and may require a home appraisal to confirm your equity.
- Refinancing: Another option is to refinance your mortgage once you have sufficient equity, which can eliminate PMI altogether.
Knowing when PMI goes away can help you plan your budget and consider strategies for accelerating equity growth, such as making extra principal payments.
Private Mortgage Insurance: FAQs
What does PMI stand for?
PMI stands for Private Mortgage Insurance.
What is a PMI payment?
A PMI payment is the cost of the insurance that protects your lender. It’s typically added to your monthly mortgage payment but can sometimes be paid upfront or in a split arrangement.
What's the difference between homeowners' insurance and mortgage insurance?
Homeowners’ insurance protects your home against damage from events like fire, theft, or natural disasters. Mortgage insurance (PMI) protects the lender in case you fail to repay your loan. Both are often required for home financing.
Does my credit score affect PMI?
Yes. Borrowers with higher credit scores generally pay lower PMI premiums, while lower scores can increase the cost. This reflects the lender’s assessment of risk. Visit Nusenda’s no-fee
Credit Score tool to view your score.
Do I have to pay PMI?
PMI is typically required for conventional loans when the down payment is less than 20%. Other loan types, like VA loans, do not require PMI. You can visit our
Fixed Rate Mortgage page here.
Is PMI tax-deductible?
Currently, PMI premiums are not tax-deductible, though past tax years occasionally allowed deductions depending on legislation. Check with a tax advisor or the IRS website for the most current information.
How can I avoid paying PMI?
- Make a 20% down payment or more.
- Explore lender options like piggyback loans.
- Consider VA loans if eligible.
Nusenda Credit Union: Your Home Financing Partner
Understanding PMI is just one step in the home-buying journey, and having a trusted partner can make the process smoother. Keep in mind that PMI protects the lender, and not the home owner or property itself. At Nusenda Credit Union, we guide our members through every aspect of home financing, from pre-approval to closing. Our mortgage loan officers can
help you explore mortgage options, understand costs like PMI, and choose the loan that fits your financial situation.
Whether you’re a first-time buyer or looking to move into your next home, we provide personalized advice and clear guidance so you can confidently navigate the mortgage process. Learn more about private mortgage insurance, your loan options, and how to finance your dream home by visiting or contacting our team today.
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