January 3, 2020

What is PMI on a Mortgage?

Private mortgage insurance (PMI) is a form of insurance home buyers pay on top of a conventional loan on a home. Generally, home buyers have to pay PMI if their down payment is less than 20% of the home's purchase price.

Private mortgage insurance is an insurance policy that protects the lending institution (i.e., a bank) in case you stop making payments on your loan. It doesn't protect you, the home buyer, even though you make the PMI payments.

One of the greatest barriers to first-time homeownership is coming up with enough cash to cover a 20% down payment. But if you get a conventional loan for more than 80% of the home's purchase price, the lender will require you to pay for PMI.

That's because home buyers who want to make a low down payment are seen as a greater risk to the lender. PMI is intended to cover potential losses sustained by the mortgage lender if you fail to make payments. You also may be required to pay for PMI if refinancing results in having less than 20% equity.

How much is PMI on a mortgage?

While the cost of PMI typically ranges from 0.5% to 1% of the loan balance each year, many factors can influence your monthly payment.

PMI costs are calculated based on these criteria:
  • Down payment amount: if you pay 20% or more of the purchase price of your home as a down payment, you will not have to pay PMI. For down payment amounts of less than 20%, the PMI rate varies.
  • Credit score: The higher your credit score, the lower your PMI payments.
  • Type of mortgage: PMI is associated with conventional loans only. The total amount of the mortgage loan: The more money you need to secure your new loan, the more PMI you will pay over the total life of the loan.
  • Loan-to-value ratio: The percentage of your home's value that was issued to you as a mortgage loan.

To calculate your monthly PMI payment, multiply your loan amount by your PMI rate and divide the answer by 12. That's the amount you'll pay each month until you've built at least 20% equity in your home.

While you can't generally negotiate PMI, you may be able to pay for your PMI upfront as a lump-sum. Some lenders may charge a higher interest rate instead of PMI.

When comparing the cost of PMI to a higher interest rate, make sure to calculate the total you'll pay for each over the life of the loan.

How can I avoid PMI?

Since PMI costs add to your monthly mortgage payment, it's understandable that you would want to avoid PMI. Thankfully, there are ways to get a mortgage loan without PMI, even if you can't put 20% down:
  • Take out an FHA loan. You'll avoid PMI even with a lower down payment, but other associated mortgage insurance premiums could end up costing you even more.
  • Take out a piggyback loan. A piggyback loan or 80-10-10 loan is a type of home loan that can help you avoid PMI, but could also end up costing you more if you don't have good credit.
  • Consider a VA loan if you are an eligible servicemember, spouse, or veteran.
  • Seek downpayment assistance. The U.S. Department of Housing and Urban Development provides downpayment and closing cost assistance to eligible low-income families that do not need to be repaid.

If you don't qualify for any of these options, or you're worried about the cost of FHA and piggyback loans, look into home co-investments.

Is PMI tax-deductible for 2020?

Thanks to a tax provision that was extended in 2019, PMI and other types of mortgage insurance premiums are deductible at least through the end of 2020. Interest on a mortgage up to $750,000 is also tax-deductible.

Closing costs, on the other hand, are not deductible unless the associated costs are actually mortgage interest or real estate tax.