How Does Private Mortgage Insurance (PMI) Work?
Many people confuse mortgage insurance with property insurance, but they are actually very different things. While property insurance (aka homeowner’s insurance) protects you in case of damage to your property, mortgage insurance is in place to protect the lender.
Private mortgage insurance can cost around $30-$70 per month for every $100,000 you borrow, according to Zillow. That could turn into a costly expense to pay over time, so you should understand how it works — and how you can avoid it altogether.
Private Mortgage Insurance (PMI) Protects the Lender
Usually, when you buy insurance, it protects you in case something goes wrong. For example, your health insurance helps you pay medical bills, your car insurance covers any accidents you get into, etc.
So you might think mortgage insurance would also protect you. However, it actually protects the lender — not you — even though you are the one who pays the premiums.
Here’s how mortgage insurance works: you pay monthly premiums for the coverage, and if you ever default on your mortgage the insurance company will pay out a claim to the lender that helps recoup what they otherwise would have lost.
In other words, your private mortgage insurance helps protect your lender.
Do You Have to Pay Mortgage Insurance?
You might think mortgage insurance sounds a little unfair, since you pay the premiums but the lender gets the benefits of the coverage. But the good news is that mortgage insurance isn’t always required.
In general, you are only required to pay mortgage insurance when you have less than 20% for a down payment. That’s because there is more risk to the lender when you put less money down. So for example, if your home costs $300,000 and you have a $30,000 down payment, your down payment would be 10% and you would need to pay mortgage insurance.
The most common type of mortgage insurance is private mortgage insurance (PMI), which is for conventional mortgages. There are other types of mortgage insurance for other mortgage loan types. For example, FHA mortgages require a type of mortgage insurance called MIP.
In this article, we’ll focus primarily on PMI since it is the most common type of mortgage insurance.
For PMI, the lender purchases the insurance through a separate, private company and charges the premiums to you. The cost of PMI is rolled into your monthly mortgage payment.
How to Avoid Private Mortgage Insurance (PMI)
The best way to avoid private mortgage insurance is to put down 20%. That may require saving up for a longer period of time, however, which may not be feasible. Some home buyers will borrow from parents or relatives to get enough cash for a 20% down payment.
Another alternative is to partner with a company like Unison that makes home ownership investments. If you have enough for a 10% down payment, the company can contribute up to half of your down payment, for a total of at least 20%, through its Unison HomeBuyer program. That means you can avoid paying mortgage insurance.
If you don’t have 20% for a down payment and don’t want to partner with a company like Unison, you might be able to qualify for what’s called a “piggyback mortgage” or “80/10/10 mortgage”. That is a second mortgage in addition to your primary mortgage, and it essentially gives you more cash to put down. However, the interest rates on these mortgages are usually higher, and they often have to be paid back over 15 years instead of 30 years, so be cautious about using this as an option.
You can also get lender-paid mortgage insurance, meaning you won’t pay for it directly, but you still pay for it indirectly in the form of a higher interest rate on your mortgage. Usually your interest rate will be at least 0.5% more when you select lender-paid mortgage insurance. Be sure to do the calculations to ensure this works out in your favor before you decide on this option.
Whatever you decide to do, make sure you get all the information from your loan officer before making a decision. Paying private mortgage insurance (PMI) can end up costing a lot, so you should be aware of all the implications before you sign up for it.