Private mortgage insurance (PMI): Why it’s sometimes required (and how to avoid it)

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Buying some peace of mind (for the lender, not for you).

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Buying a home is a complex transaction, with mountains of paperwork full of jargon, confusing terms, and above all, costs and fees. One of those potential costs—if you’re taking out a mortgage—is private mortgage insurance (PMI). Private mortgage insurance is designed to protect the lender in the event you default on your loan.

Is your lender requiring PMI? Here’s what you need to know, including the expected cost, how long you’ll be expected to pay it, and how you can sidestep this potentially budget-busting expense.

Private mortgage insurance (PMI) is a cost you pay when you take out a conventional mortgage and your down payment is less than 20%. Because the lender is providing the up-front cash for your home, they risk taking a loss if you stop making mortgage payments. By requiring you to pay for PMI, you cover some of that risk in the same way you pay for other types of insurance.

But it’s important to understand that PMI is an additional cost that’s tacked on to your monthly payment. Like your property taxes, home insurance, and perhaps dues to a homeowners association (HOA), it’s an expense above and beyond the cost of your mortgage.

In general, you pay PMI as a monthly premium when you make your mortgage payment. (Sometimes you pay it up front, but if so, you might not be able to get a refund of the premium if and when the mortgage insurance is no longer necessary.)

Information about your mortgage insurance premium cost and how you’re paying for it should be included within the documents you review and sign at your closing. Pay attention to when the payments are due and the type of premium you pay. Once you reach a certain point in your loan, you can request that the PMI be removed (see below).

How much you pay in PMI depends on the size of your loan and the percentage your lender uses to calculate your premium.

For example, let’s say you buy a home for $250,000 and put 5% down. Your down payment is $12,500, meaning you’ll borrow $237,500.

The lender will determine your annual premium based on a percentage of your loan amount. For example, a common percentage is 0.51%. Your lender will multiply 237,500 x 0.0051 to get a total of $1,211.25 for your annual PMI premium. Divide that by 12 monthly payments, and you end up paying an extra $100.94 per month.

In subsequent years, your premium will depend on the type of PMI you have:

Once you pay down your mortgage to the point where you have 20% equity, you can request that your lender remove the private mortgage insurance.

Once your principal balance reaches 78% of the original home value, the lender must automatically remove the PMI requirement. And once your home reaches the midpoint of its amortization schedule (e.g., the 15-year mark of a 30-year mortgage), the lender must remove PMI, even if your home has declined in value.

If you don’t want to wait for your lender to automatically remove your PMI, you can ask for it to be removed. You have to be up to date on your loan, and you have to be able to show that your loan-to-value (LTV) ratio has reached 80% (in other words, that your home’s equity value is 20%).

Once you’ve shown that, and if there are no second mortgages on your home, you can request PMI removal in writing. The lender will review the situation and cancel the PMI if you meet the criteria.

There are three main ways to potentially avoid paying PMI. However, it’s important to weigh the pros and cons of each before moving forward.

Make a 20% down payment. When you put 20% down on a conventional mortgage, you don’t have to get PMI at all. If you can save up enough for a 20% down payment, or if you have a family member who will gift you the funds, you can avoid PMI.

However, it can take years to save up for such a large down payment, especially if you live in a high-priced metropolitan area. For some would-be homebuyers, a full 20% down payment simply isn’t feasible, even if it would allow them to avoid PMI.

Use a piggyback loan. In some cases, a lender will let you take an immediate second mortgage to make up the difference between your down payment and the 20% requirement. In our example above, you’d put down $12,500 (5% of $250,000) and then get a second mortgage for $37,500.

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It’s important to note that the second mortgage will have its own separate interest rate—and it might be a substantially higher rate. Depending on how the numbers work out, getting a piggyback loan to avoid PMI could potentially cost you more in the long run. Use a loan calculator to review different scenarios and determine the best deal for you.

Get a different type of loan. Private mortgage insurance applies only to conventional mortgages. In some cases, you can use a different loan with a lower down payment and avoid PMI. However, such loans usually come with their own fees.

For example, a Federal Housing Administration (FHA) loan allows you to put as little as 3.5% down. But you’ll pay an up-front mortgage interest premium (UFMIP) of 1.75% of the loan amount, plus an annual mortgage insurance premium based on how much you put down. Typically, you can have the insurance cost removed after 11 years if you put down at least 10%.

Other loans, such as those offered by the U.S. Department of Agriculture (USDA) and the U.S Department of Veterans Affairs (VA), come with their own funding fees. Compare the cost of these fees, their duration, and your down payment with the total cost of PMI for a conventional mortgage.

Private mortgage insurance makes it possible to qualify for a home loan with a down payment of less than 20%. However, you’ll pay a cost to the lender to cover for the increased default risk—and that cost is PMI.

Although you can have it removed later on, if you’re weighing the choice between buying and renting a home, PMI is an additional monthly fee to consider over and above your mortgage payment, property taxes, maintenance, and all the other costs of owning a home. Carefully weigh all the costs of homeownership against your monthly budget before deciding whether to proceed and how much to borrow.