What is PMI?
Private mortgage insurance is a type of insurance the borrower may have to pay if they don’t have 20% for a down payment. Lenders rely on these payments to mitigate financial risk when issuing mortgages for first-time homebuyers or for loan refinancing.
When is PMI required?
PMI payments are required in two circumstances:
- For conventional loans without a down payment of at least 20%
- For refinancing loans where the loan-to-value ratio exceeds 80%
Some lenders will approve you for a conventional loan with as little as 3% down. But to protect themselves against this financial risk, they’ll ask borrowers to make monthly private mortgage insurance payments. These monthly payments are usually rolled together with the monthly mortgage payment. Keep in mind that some loan programs do not require these payments.
USDA and VA loans don’t require any down payment, nor do they require private mortgage insurance.
How is PMI calculated?
Your total private mortgage insurance amount will always be a percentage of your total mortgage. The average PMI costs are between 0.22% and 2.25% of your mortgage. But your exact percentage will depend on your lender as well as your own financial situation.
PMI payment methods
Several PMI payment methods are available, with advantages and considerations for each.
-
Monthly premium
The monthly premium approach involves spreading the insurance cost over the life of the loan, adding a predictable amount to the borrower’s monthly mortgage payment. This option suits those seeking a lower upfront cost and prefer to budget for a steady, consistent PMI expense.
-
Upfront premium
In contrast, the upfront premium requires a lump sum payment at the loan’s origination, potentially reducing monthly mortgage payments and overall interest. It is an attractive choice for individuals with extra funds at the outset and those eager to minimize long-term financial obligations.
-
Upfront premium combination
Lastly, the upfront premium combination method allows borrowers to pay a partial upfront premium, reducing their monthly PMI payment while still enjoying some of the benefits of the upfront approach. This hybrid approach may be appealing to borrowers seeking a balance between immediate savings and ongoing affordability.
Factors that affect PMI
The exact amount of your private mortgage insurance payments will depend on a number of factors. The following factors will influence your rates.
-
Loan-to-value ratio (LTV)
You can avoid PMI payments altogether if your loan-to-value (LTV) ratio is 80% or better. Otherwise, you can expect your LTV to directly influence your PMI rates.
You can determine your LTV by:
- Identifying the value of the property (from the appraisal)
- Identifying your home loan amount (minus any down payment)
- Dividing the home loan by the home price
Basically, this means that a lower down payment translates into a higher LTV ratio. A higher LTV spells more risk for your lender, which means that your PMI rates may increase.
-
Credit score
In addition to your home’s LTV ratio, your lender will also look at your credit history. Again, lenders require you to pay PMI to protect themselves against lending risk. A strong credit score won’t eliminate your need to make PMI payments, but you may see more favorable rates when your credit score is high.
-
Debt-to-income ratio (DTI)
Your lender will also look closely at your debt-to-income ratio (DTI). To calculate this ratio, simply divide your average monthly debt by your average monthly income.
Most lenders are looking for a DTI ratio of 43% or lower. A higher ratio indicates greater financial risk, so your PMI providers may raise the value of your monthly PMI payments.
How to estimate PMI
Your lender can provide you with your expected PMI range. Alternatively, you can use the average range (0.22% to 2.25%) to make an estimate of your expected monthly PMI payments.
To calculate your PMI payments, simply multiply your total loan amount by your PMI percentage. The result is your annual premium. Divide this number by 12 to calculate your estimated monthly payment, though remember that this number will be added to your mortgage premiums.
So if your home’s total value is $270,000 and you put down $20,000, your mortgage amount will be $250,000. You can calculate your PMI range by multiplying this number by the upper and lower limit:
- 0.22%: $550/year, $46/month
- 2.25%: $5625/year, $469/month
This difference highlights why it’s beneficial to keep your PMI payments as low as possible — or avoid them altogether.
How to avoid PMI
Naturally, you want to avoid PMI payments, which only add to your monthly mortgage premiums. Here are several ways to get out of PMI payments.
- Make a 20% down payment: The best way to avoid private mortgage insurance is to simply make a traditional 20% down payment. Yes, this can take a bit longer to save, but it will help you avoid the added cost of PMI payments. Additionally, a higher down payment may help you qualify for a larger mortgage and open up better lending options.
- Pursue a higher-interest loan: PMI payments and interest payments actually serve the same purpose — they both protect lenders when issuing large loans such as a traditional mortgage. You may be able to avoid costly payments by agreeing to a higher interest rate. Just be careful that you don’t end up paying more in interest than you would with a monthly PMI payment.
- Consider other loan options: If you can’t afford a 20% down payment, there are other loan types available. USDA loans and VA loans don’t require any down payment, though each has its own eligibility requirements. CrossCountry Mortgage’s Bye Bye PMI loan program is another way to avoid PMI.
The same can’t be said for loans backed by the Federal Housing Administration (FHA). As long as your credit score is above 500, you may qualify for a loan with a down payment as low as 10%. You may qualify for even less down if your credit score is at least 580.
But FHA loans down require you to pay something called a mortgage insurance premium (MIP) that serves the same function as a private mortgage insurance payment.
Final thoughts
On the one hand, private mortgage insurance payments add to your total cost. But they can become a necessary expense for homebuyers looking to purchase a home with less than 20% down. Thus, they protect lenders while empowering buyers to find the home of their dreams without sacrificing their savings.
