When you go to buy your first home, the topic of private mortgage insurance (aka PMI, or lender’s mortgage insurance) 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)?
Private 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 (and you pay prime rate, plus a few percentage points on them). 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. It could be a home equity loan or HELOC though.
I learned my lesson on my second home and put more than 20% down to avoid PMI costs. In my opinion, you shouldn’t avoid putting 20% down on your mortgage.
Is Mortgage Insurance Tax Deductible?
In many cases, PMI is tax deductible today, but it does depend on whether you claim the standard deduction and your tax bracket. You would need to itemize your taxes in order to deduct it – and approximately only 10% of taxpayers do. Post tax-reform and higher standard deductions, buying a home for tax deductions is bad advice. Mortgage insurance had not been tax deductible up until 2007.
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.
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 it, 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.
There are a few exceptions to the Homeowners Protection Act:
- If your loan is considered “high-risk.”
- If you have not been current on your payments within the year prior to the time for termination or cancellation.
- 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.
If mortgage rates are lower today than when you originally took out the mortgage, you may be able to get rid of PMI if and when you refinance as well.
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 overrated, 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?