What is private mortgage insurance?

When learning about borrowing for a house, you may hear the term “private mortgage insurance,” commonly called “PMI” in banker lingo.

You may have also heard that you don’t always need to put 20% down for a home. It’s true: Some house hunters are turning into homeowners with just a 3% down payment.

But there’s one caveat: Conventional mortgage lenders often require PMI for borrowers putting less than 20% down. A conventional loan is any mortgage loan not insured by a government program. So, what is PMI? It’s a lender insurance policy that gives you the ability to buy a house with a down payment of less than 20% by protecting your lender if you fall behind in your monthly mortgage payments.

Private mortgage insurance and homeowners insurance are two different things. PMI covers your lender if you default on your mortgage, and homeowner’s insurance covers losses and damage to your house and its belongings if something unexpected happens, such as a fire or hail damage.

Your payments will end automatically once you have 22% equity in your home. Your servicer must terminate PMI the date your home reaches 78% of its original value of your home as long as you stay current on mortgage payments.

You can request to cancel your PMI once you have 20% equity in your home, which means your principal balance reaches 80% of the original value of your home. The date will appear on a PMI disclosure form when you receive your mortgage. "Original value" refers to the contract sales price or the appraised value of your home at the time you purchased it, whichever is lower (or the appraised value of a refinance if you refinanced your mortgage).

If you want to cancel PMI on your loan, you must make the request in writing, be current on your payments and have no junior liens on your home. Your lender may also need evidence that home value hasn't declined below the original value of your home.

A low down payment can make it easier or faster to get your dream home, but you might be worried about the additional cost that comes with private mortgage insurance. So, should you wait until you have that magic 20% down payment?

If you’re a renter and the only thing in your way of buying is the down payment, consider this: By the time you save enough to make that 20% down payment, there’s a chance you’ve already spent the money you “saved” on PMI on your rent. But each person’s financial situation is unique, and there may be certain scenarios where it makes sense to wait to buy and avoid the expense of PMI.

Tip: Some homebuyers choose to reduce their down payment amount if it only slightly increases their PMI payment. That way, they have cash available for the other upfront costs of buying a home, such as renovations or furnishings.

If you are wondering how to avoid PMI altogether, the best way is to make at least a 20% down payment on your home. You may also look into different types of loans that do not require PMI, such as FHA and USDA loans, but keep in mind these types of loans still require their own forms of mortgage insurance.

Trying to decide whether or not it’s the right time to buy? Planning your down payment strategy? Even though you’ve always heard that you need to make a 20% down payment, that’s not always true.

A great way to understand your options is to explore each scenario with an Ally Home loan expert. They can help you understand how PMI could allow you to buy a home sooner than you expected, how your financial numbers could affect its cost and what makes the most sense for your unique circumstances.