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.
PMI premiums can be added to your monthly mortgage payments, or, in some instances, you can pay the premium upfront. Some lenders also offer “lender-paid” mortgage insurance, meaning they pay for your mortgage insurance upfront, and you repay them every month with a slightly higher interest rate.
Private mortgage insurance vs. homeowners insurance
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.
How much does PMI cost?
PMI rates depend on several factors, but typically, you can expect to pay between 0.5% to 2% of your loan amount per year for PMI. Your unique rate depends on multiple factors, including:
Down payment percentage: The larger your down payment, the lower your mortgage insurance payment.
Credit score: The higher your credit score, the lower your mortgage insurance payment. (If your score needs a boost, these tips could help.)
Debt-to-income (DTI) ratio: Your DTI ratio is your total monthly debt payments divided by your gross monthly income. Lenders will take DTI into consideration when deciding if you can qualify for a mortgage, but if your DTI is at 50% or higher, you may not be approved for the loan.
How long do you pay for PMI?
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.
When PMI can be canceled
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.
Is PMI worth it?
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.
How can you reduce the cost of PMI?
In some instances, a boost to your financial profile will only slightly improve your PMI pricing. But it is possible to save on mortgage insurance by improving a few of your numbers.
Improve your credit score because it affects your mortgage interest rate and your PMI pricing. If you have a flexible timeline, it might make sense to hold off on buying a house until you can get your score in good shape.
Shop for more affordable homes without changing your intended down payment amount. Doing so will boost your equity relative to your home’s value, so you’ll be closer to 20% without saving more for your down payment. It will also reduce your loan-to-value ratio (LTV), which is the amount you’ve borrowed divided by the purchase price of the property. Lenders will offer you the lowest interest rates when your LTV is at 80% or lower.
If lowering your price range isn’t possible, (especially if you’re looking in a competitive housing market), opt for making larger monthly mortgage payments, so you can reach the 20% equity needed to cancel PMI sooner.
Consider HomeReady®, an affordable lending program similar to the government's FHA loan program. HomeReady® comes with cancelable private mortgage insurance. And if you plan on making a down payment below 10%, this option will reduce the standard PMI coverage requirements, so you’ll receive better PMI pricing as well.
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.
Understand your options
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.