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Home » Home Buying, Home Ownership

What is Private Mortgage Insurance (PMI)? And how can you Avoid or Get Rid of it?

Last updated by on 25 Comments

When you go to buy your first home, the topic of private mortgage insurance (PMI) will assuredly come up.

It’s a dirty little three-letter acronym associated with your pending mortgage that you should know inside out.

Why?

What you decide to do around the PMI conversation could potentially cost or save you thousands of dollars, possibly tens of thousands, over the life of your mortgage.

As such, file this one under the “I can’t believe I’ve never blogged about this before” category.

In this post, I’ll address what PMI is, how to avoid it from the start, and how to get rid of it at a later point in time.

What is Private Mortgage Insurance (PMI)?

PMIPrivate mortgage insurance, or PMI, is an insurance policy that compensates lenders (i.e. banks) in the even of a default on a mortgage. It is also sometimes referred to as “lenders mortgage insurance”, or LMI. One could also refer to it as MPA, or Major Pain in the Ass.

“Hmmm… insurance for lenders on their investment? They must pay for it, right?”

Nope! Not only do they not pay for it, they even make you pay for the PMI policy costs on your own mortgage!

“Wait, you pay them significant fees to borrow their money, and on top of that they charge you for any assumed risk? That’s kind of like “You scratch my back, I’ll scratch mine” isn’t it?”

You got it!

How Much does PMI Cost?

Private mortgage insurance cost varies widely. Lenders will factor in your credit score, income, and loan-to-value (LTV) ratio.

Typically, PMI cost ranges from 0.5% to 1.0% of the total loan amount, on an annual basis.

So, if you have a $200,000 loan, a 1% PMI rate would equate to $2,000 per year, or $166 per month.

This is on top of the 3-5% you are already paying them on the mortgage rate!

How to Avoid PMI from the Beginning

PMI can be avoided altogether with one simple tactic: put down (pay at the beginning) a minimum of 20% of the price of the home.

Lenders usually require mortgage insurance for mortgage loans which exceed 80% of the property’s sale price, or assessed value.

It’s that easy. Getting the 20%? That’s the hard part.

A second way to avoid PMI is to take out a second mortgage to cover anything over the 80% that your mortgage or down payment does not. This is often referred to as a piggy-back loan. When I bought my first home, I did this, as highlighted in my stupid mistakes post. The second loan is usually at a higher interest rate and is adjustable with the prime rate. In my case, it was a home equity line of credit (HELOC) and it held a 3% higher APR than my mortgage.

I learned my lesson on my second home and put more than 20% down to avoid PMI costs.

Is Mortgage Insurance Tax Deductible?

In many cases, PMI is tax deductible today, but it does depend on your tax bracket. Mortgage insurance had not been tax deductible up until 2007. There is also the possibility that it may not continue to be.

For the time being, if you are putting less than 20% down, it may be possible that tax deductible PMI on top of your mortgage is cheaper than a second loan. It is definitely worth calculating.

Check out the IRS mortgage insurance article for more info on who is eligible. If you are eligible, you would use IRS form 1098.

How to Get Rid of PMI on an Existing Loan

The Homeowners Protection Act of 1998 dictates that for home mortgages signed on or after July 29, 1999, your PMI must – with certain exceptions – be terminated automatically when you reach 22 percent equity in your home based on the original property value. Your PMI also can be canceled, when you request – when you reach 20 percent equity in your home based on the original property value.

In order to have this happen, your lender will likely require you to get a property appraisal, which can cost you a few hundred dollars.

One exception to the Homeowners Protection Act is if your loan is considered “high-risk.” A second is if you have not been current on your payments within the year prior to the time for termination or cancellation. A third is if you have other liens on your property. For these loans, your PMI may continue. Ask your lender for more info about these requirements.

The Bottom Line on PMI

As Americans, we think we all have the right to a home. And many of us are willing to push risk aside to achieve that “American Dream”.

The thing is, you don’t really own “your” home until you have it 100% paid for (and with property taxes, it’s even debatable whether you truly own it then).

Paying thousands extra because you cannot afford to put 20% down on the home does not make good financial sense.

Home ownership is way over-rated, in my opinion (and I’ve owned two). At a minimum wait until you can put 20% down on the home. It won’t kill you.

Don’t make the same mistake I made on my first home.

Private Mortgage Insurance Discussion:

  • Have you used PMI or a second mortgage – or, did you wait to buy until you could put 20% down.
  • If you did use PMI/second mortgage, was it worth it? Or do you wish you would have waited instead?

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25 Comments »
  • I wouldn’t bet on PMI being tax deductible going forward. It is best to have a 20% down payment to avoid the PMI in the first place. That said, people often overlook the closing costs/prepaid items that are due at closing. I know that in my state, closing costs and prepaid items will be around $7,000 for a ~$200,000 home. So for a $200,000 home, you will need $47,000 at closing not $40,000 to avoid that PMI.

  • Ryan says:

    Through our credit union, the PMI on the house we are buying with 10% down is going to be about $38 per month. With the interest rate that we are getting, plus the cost of the home, the home insurance, and the property taxes, our monthly payment is going to be $700 for a 4 bedroom, 2 bathroom 2000 sq ft home. This is our first one.

    Because of our kids we need a place that is at least 2 bedrooms with a little space to move. To rent a 2 bedroom condo/townhome in our area would run us about $900 a month. When you think of the money that is going towards equity, the fact that we have a much nicer place to live, and that we are paying $200 less a month on our home, I am ok with paying the extra $40 for PMI that will decrease over time. Am I wrong in my thought process?

    From what I’ve seen the PMI rates are insanely higher on FHA loans as opposed to conventional loans.

  • Kevin says:

    We had PMI on our first mortgage and we quickly acted upon removing it as it was costing us $160/month. Months after our closing, we took out a second loan to put towards the house that got us over the 80% hill. The mortgage company still would not allow us to remove the PMI due to small text requirements. With countless phone calls and debates with our mortgage holder, we got lucky with timing and refinanced our year-old mortgage to someone else, and was able to save a months worth of payments when it came time to close. The second loan, through our parents btw, is working out great with the interest we are paying. If you have a relationship you can trust to get the money to remove PMI at the beginning, do it! Your retirement will thank you down the road.

  • R S says:

    When I bought my home, my financing options were as follows:
    1) 90% 30 yr fixed-rate1 + 10% down + PMI
    2) 80% 30 yr fixed-rate2 + 10% 30 yr 1.5% higher-fixed rate + 10% down

    In terms of overall payments, the PMI option was ~50 cheaper than the 2 loan option.

    I chose the 2nd option for a couple reasons:
    1) PMI was deductible then, but not guaranteed forever
    2) Removing PMI would require re-appraisal of the property. If property value dropped (which was/is likely at the time), paying down 10% of the purchase price did not guarantee the 20% equity required to remove PMI.

    The second reason was my most compelling reason not to get a loan with PMI. If I accelerated payments on my 2nd smaller loan, I could eliminate a payment entirely, whereas eliminating PMI was iffy.

    A drawback to having 2 loans is refinancing.When talking to other lenders for quotes, however, some balked entirely at having to subordinate a second loan or preferred to roll the two loans into one & hit me with PMI.
    I got lucky & refinanced with the same lender, so I didn’t actually have any trouble, except in getting quotes.

  • Ron Ablang says:

    Right on G.E. When I bought my 1st home (that I still own to this day), I did put down 20%+ on buying my home. Thus, I never had to worry about wasting money on PMI since.

    Future homeowners should be aware of this.

  • Jeff Walden says:

    “Hmmm… insurance for lenders on their investment? They must pay for it, right?”

    Nope! Not only do they not pay for it, they even make you pay for the PMI policy costs on your own mortgage!

    This isn’t the right way to look at the allocation of costs. The right way to look at PMI is that you are paying extra so that you will be given a larger loan. No pay extra, no larger mortgage for you.

    Moreover, even if you want to look at it the way you phrase it, the incidence of the cost of PMI would still be on you even if the lender were to pay for it. For a lender to have money to buy PMI, he would have to earn that money. How does a lender earn money? By receiving interest from those who purchase mortgages. The lender to purchase PMI would simply rearrange the flow of money. And because it would be more troublesome in such instances to determine the risk of default PMI is intended to guard against, having the lender purchase PMI would just increase the overall cost to the homeowner. (If the insurer didn’t make that determination, it would only make the cost worse to the homeowner requiring that extra insurance.)

    Of course, the right way to look at PMI, as you rightly point out, is as something you should never use: pay 20% of the cost when you buy the house. And if you can’t do that, perhaps you should consider renting or making do in some other way for a bit longer.

  • Patrick says:

    I just payed off my loan to the 80% mark and requested the PMI cancellation information. They responded that I must pay for an appraisal to determine the current value of the property.

    I thought the law stated that the request needs to be honored when the 80% mark is reached based on the original value (lesser of appraisal or purchase price).

    How should I respond?

  • camelian says:

    It might be helpful to note also that on FHA loans (and perhaps some others), you are required to pay PMI for at least 5 years if you put down less than 20% REGARDLESS of whether you reach 78% LTV earlier or not.

    I purchased my house recently with 3.5% down on an FHA loan but in my case I decided it was worth the 5 years of PMI b/c even if I went conventional I only had enough to put down about 10%, which would yeild me a higher interest rate in addition to still having some PMI. The FHA loan got me the lowest interest rate available and allowed me to keep a larger emergency fund. It would have been more ideal to wait until I had 20% saved up but I had 2 roommates ready to move in with me and now have a 3rd, offsetting the extra PMI. I’m currently making some extra payments and should reach 78% LTV right at 5 years

    Question for clarification. When you say 78% principal balance to “original property value”, is that the appraisal that came in for the house at the time of purchase?

  • Carrie - Careful Cents says:

    I too purchased a home and ended up paying PMI every month. I definitely agree with your statement of “owning a home is overrated”. It’s nice to own your own place, but not if you don’t do it the right way and save up the 20% down payment (or more). Going forward I will NOT own another home until I’m financially prepared. Life experience was a good teacher in this case.

  • Warren says:

    From a bank’s perspective, if someone defaults on a home loan, the loan goes into foreclosure, the bank has to possibly repair the house and then sell it, then the bank would probably get somewhere around 80% of the value of the house. That’s where the 80% came from in the first place.

    PMI is basically insurance against that part of the loan that the bank would not be able to recover in the case of a default. In the case of a default the PMI issuing company would possibly pay off the loan to the bank and handle the selling of the house at a loss.

    This thing about banks originating a second loan for everything above 80% seems pretty bogus since the whole reason for the 80% cutoff is to keep the bank out of loaning more than 80%.

    For many people, the problem is not PMI, the problem is buying more than they need to live in. If someone is paying rent with little left over, they might never save 20%, especially if house prices and rental rates are going up. Despite the current situation, most years these prices go up.

    In my own case, I moved out of an apartment into my condo. Because this is a condo, the total of both the mortgage payment (including taxes) and condo fees is less than what the same space would have cost me for a house and less than what rent would have been. If I had to buy PMI, the cost would be about equal to rent and still less than the house. If I assume that at some point the housing market will recover, then at some point my monthly costs will be significantly less than rental.

    Many people look for a “starter home” for their first home. There is no specific home that is a “starter home”. A starter home is what someone can afford when they buy their first home to start building equity to use as the down payment for their next home. What a billionaire’s kids might buy as starter homes might be more than I could ever think of owning. A friend bought a “starter home” for $162,000, which needed about $20.00 of work. This was the least expensive house in an expensive part of the city. For about $90.000 they could have bought a condo. On top of that, they bought the more expensive second mortgage for the mortgage above 80% instead of taking the PMI which would have been cheaper.

    PMI also allows someone to not deplete their emergency fund. In that case the PMI is really insurance to allow the emergency fund, not because there wasn’t enough money to make a 20% down payment.

  • Marcelina Hardy says:

    A few years ago PMI was something everyone should have had, but nowadays, it’s best to go ahead and forgo it. Like the above poster stated, the only way to save the 20% is if the prices don’t go up, and they are going to, so it’s best to save yourself.

    Just buy a home that is less than you can afford and you should be A-OK.

  • Justin says:

    When I first started looking to buy a home, I was totally against PMI. Didn’t want it, felt it was throwing away money and might as well just flush $20s down the toilet.

    However, when I found the house I wanted to buy after looking for about a year, I had enough for the 20% down, but just barely. I could have bought a lesser house, but found a perfect “30 year home” or what I would (assuming no major life changes) like to keep, raise my kids in and grow old in.

    The price was $285K so 20% was about $57K. My choice was to plop down the $56K and have nothing in reserve or look for a “starter home” for less and move after 5 or 6 years when home prices are possibly higher and interest rates are almost certainly going to be higher, or go with 5% down, pay $151.14 in MI and hold out about $42K to keep in reserve in case of emergencies, loss of income, or other unforeseen expenses. The way I figure it, I’m paying $151.14 for a “loan from my home” in the amount of $42K which equates to about 4.24% interest only for about 7.5 years.

    To me, that is much better than avoiding the $150 a month in MI and having to borrow money at a much higher interest rate if I have some sort of urgent need or loss in income. As Warren mentioned above, it seemed much more safe for me to do this than put $42K more up front just to save $150 a month. I’m actually just thinking I might just prepay the MI at $6600 and just have it over and done with. It’s a WAY better rate than you’d get from a home equity loan, credit card, or other method of getting cash in case of an emergency.

    I had way too many friends lose their houses because of job loss, medical expenses, or some other major problem and then not be able to make their mortgage payment. I’d rather keep out 15% in reserve and not have to worry about not being able to make my bills. Plus with an interest rate at 3.25% on the home loan, I don’t really care about the amount of interest I’d save by paying more. Inflation and time value of money will compensate for this.

    Of course I could be wrong and perhaps missing something major (first time home buyer so I’m not super experienced with all this), but it seems like in the current housing market, interest rates and economic situation, MI can allow for a nice safety net and allow a person to get into a long term home purchase (if that is their plan) that is better for them.

    • Willsmom says:

      I think this is a great example of a situation when PMI can work to your advantage. I’m in a similar boat. I could have reached 20% down by taking money out of my retirement fund. However, I got a mortgage interest rate of 3.6%. Even with relatively measly returns on my retirement investments, my money is still making more money than it costs me to pay a $150/month PMI for a few years.

  • Nick says:

    One thing you forgpt to mention is that if you go with an FHA loan with PMI, you cannot get rid of it until the 5 year mark. So even if you make it to 20% sooner you have to wait until the 5 year mark to get rid of it.

    However I disagree with you to wait until you have 20%. As prices for homes are at all time lows you may very easily make up the difference in the quality/price you get on your new home.

  • Lee says:

    If you get a mortgage of $315,000 on a home valued at $405,000 because of market? Do you still have to pay PMI since loan is more then 20% less of value?

  • mohan says:

    According to the Fannie Mae Website efanniemae.com
    Re. Fannie MAe Charter :
    The mortgage insurance is only required to cover any loan balance in excess of 80%.
    In other words if you put down 5% on a $200,000 loan ($10,000)
    The mortgage insurance required is only to cover 15% of the loan. (ie. 95% – 80% =15%)

    Yet why do lenders calculate and charge the borrower for the entire loan balance (ie. $200,000 – $10,000 = $190,000).

    Can someone please explain why lenders charge you for the entire loan balance…when the Fannie Mae requirement is to cover the
    loan amount in excess of 80%

  • CBS says:

    To say that EVERYONE should plunk down 20% on your purchase as a blanket statement is just plain false. Everyones case is different, and as pointed out here by some of the latest posts paying the PMI vs. spending your reserve is just plain smart IMHO.

    I currently pay $1,800 a month in rent. Locally rent for a similar set up can fetch as much as $2,200 a month.

    3 – 4 bedroom houses on the market here on Long Island sell for around $300K to $350K. At 3.5% ( FHA ) mortgage payments ( not including property taxes ) are $1,350 to $1,572 a month. Property taxes can add another $700 to $800. That right there is the same as paying my rent, but i am paying for my house, not someone elses.

    To take on another $125 – $150 for PMI @ .5% is a no brainer. And with me putting 3.5% down it too allows me to keep money in an emergency fund should i miss work or need to replace a hot water heater.

    Right now houses are cheap and so is borrowing money. For those who have good credit and not a huge bank roll to put down on a house it will allow the common man a chance to buy his/her own lil slice of heaven.

    • Warren says:

      PMI was created to fill a specific need. For most of recent history (since the great depression) housing costs and values have gone up. For most of that time while people would save for a down payment, the cost of the house they wanted would keep going up. PMI would give a first time borrower the opportunity to buy the house sooner, at lower cost. The savings in purchase costs would pay for the PMI insurance. This is in addition to the benefit of paying rent for a shorter period of time and building equity earlier. In today’s market, if I was buying my first house and had 20%, I would keep much of that liquid and take the PMI. If I had just 10% or less, my first concern would be how much to keep liquid and then take as much PMI as necessary.
      A dozen years ago, I was talking to someone at work who just had a child and was complaining about how hard it was to save for a down payment with the baby costs. I suggested using PMI and getting a small house. He ignored my advice and continued to save but since the housing prices started to rise spectacularly, the 20% was a moving target. By the time he caught up with his savings and bought a house, everything was way overpriced so because the market collapsed his mortgage is currently underwater despite the 20% down payment. So he lost his 20%, that part of his payments that went towards his principal, and some of what he borrowed. His house is worth slightly more than what he would have paid for it a dozen years ago so had he bought then, he would have about 25% equity against the current value.

  • Raymundo Gavina says:

    I knew we put more than 20% down payment and still we have extra thousands of dollars to that was supposed to be included with our down payment but because they don’t want to mess with the numbers, the extra thousand of dollars we took out from my wife 401k was withheld or it’s in our hands. I still have to ask my son, the ower of the house to see where the papers are located just in case you’ll ask for some numbers. I really want my son to refinance to a lower rate and get rid of the PMI, thank you

  • RNT says:

    For those who are wondering, PMI is deductible for tax year 2013.

  • kelly says:

    I purchased a short sale home almost 2 years ago. I put 10% down and am paying an arm and leg on pmi. My home is now worth 60k more than I purchased it not to mention the $11k that I’ve already paid down. Is there anyway to remove the pmi without refinancing?

    • Warren says:

      You should talk to your lawyer. If you are not happy with the lawyer that you had, try a different lawyer. If you didn’t have a lawyer when you bought the home, look into getting one. Lawyers will generally see you the first time for free to see if it makes sense to use their services. It’s not that anyone is doing anything illegal, it’s that the lawyer is generally the ONLY person who is working for you (your realtor gets paid by the seller, a mortgage broker make more money by NOT finding you the best deal, the bank is trying to get you to pay the most to them, …)

      PMI should NOT cost an arm and a leg. Historically, PMI was between 1/4 to 1/2 percent. Only when the real estate market went crazy and they took on mortgages that they previously would never touch did they raise the rates to absurd levels to cover the expected increase in losses.

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