Buying a home usually has a monster obstacle: coming up with a sufficient down payment. How much you put down on a conventional mortgage — one that’s not federally guaranteed — will determine whether you’ll have to buy PMI, or private mortgage insurance.
Typically a lender will require you to buy PMI if you put down less than the traditional 20%.
» MORE: Down payment strategies
What is private mortgage insurance?
PMI is insurance for the mortgage lender’s benefit, not yours. You pay a monthly premium to the insurer, and the coverage will pay a portion of the balance due to the mortgage lender in the event you default on the home loan. The insurance does not prevent you from facing foreclosure or experiencing a decrease in your credit score if you get behind on mortgage payments.
PMI is insurance for the mortgage lender’s benefit, not yours.
The lender requires PMI because it is assuming additional risk by accepting a lower amount of upfront money toward the purchase.
Mortgage insurance for federally guaranteed loans, such as FHA loans and USDA loans, operates a little differently from PMI for conventional mortgages. VA loans don’t require mortgage insurance, but do include a “funding fee.”
» MORE: What Is mortgage insurance?
How much is PMI?
The average annual cost of PMI typically ranges from 0.55% to 2.25% of the original loan amount, according to Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute.
At those rates, for a $300,000 mortgage, PMI would cost anywhere from $1,650 to $6,750 per year, or approximately $137.50 to $562.50 per month.
The cost of private mortgage insurance is based on several factors:
- The size of the mortgage loan. The more you borrow, the more you pay for PMI.
- Down payment amount. The more money you put down for the home, the less you pay for PMI.
- Your credit score. PMI will cost less if you have a higher credit score.
- The type of mortgage. PMI may cost more for an adjustable rate mortgage than a fixed-rate mortgage. Because the rate can go up with an adjustable rate mortgage, the loan is riskier than a fixed-rate loan, so PMI is likely higher.
Estimating the cost of PMI before you get a mortgage can help you determine how much home you can afford.
Typically, the PMI cost, called a “premium,” is added to your monthly mortgage payment. You can see the premium on your loan estimate and closing disclosure mortgage documents in the “projected payments” section.
Sometimes lenders offer the option to pay the PMI cost in one upfront premium or with a combination of upfront and monthly premiums.
» MORE: Calculate your PMI
Is PMI tax deductible?
Unlike mortgage interest, mortgage insurance premiums are not tax deductible. The federal itemized tax deduction for mortgage insurance expired on Dec. 31, 2017.
A U.S. House bill to make the mortgage insurance tax deduction permanent was introduced in January 2019, but has yet to move out of the House Committee on Ways and Means.
When can you stop paying PMI?
Once your mortgage principal balance is less than 80% of the original appraised value or the current market value of your home, whichever is less, you can generally get rid of PMI. Often there are additional requirements, such as a history of timely payments and the absence of a second mortgage.
How to avoid PMI
Mortgage insurance allows a lot of people to become homeowners who otherwise might not be able to. And it’s natural to want to put down as little money as possible, but make sure you consider the real costs, such as paying for mortgage insurance.
You can avoid PMI by:
- Saving enough to make a 20% down payment. A larger down payment offers advantages beyond lowering the monthly mortgage payment. You’ll also avoid PMI, get a lower mortgage interest rate, pay fewer fees and gain equity in your home faster.
- Paying a higher interest rate. Usually you’ll be required to pay for PMI if your down payment is less than 20% of the home price. But sometimes lenders won’t require PMI for smaller down payments and will charge a higher interest rate instead, according to the Consumer Financial Protection Bureau.
- Saving for a 10% down payment and getting an 80-10-10 loan. Sometimes called a “piggyback loan,” an 80-10-10 loan lets you buy a home with two loans that cover 90% of the home price. One loan covers 80% of the home price, and the other loan covers a 10% down payment. Combined with your savings for a 10% down payment, this type of loan can help you avoid PMI.
Ultimately, deciding whether to save more for a down payment or pay for PMI is a matter of balancing your short-term financial capabilities with the realities of your local real estate market, as well as your future savings and earnings potential.