What is private mortgage insurance?

You’re ready to jump into homeownership, but first you need to figure out more about mortgages. By now, you may already know you don’t need a 20% down payment to buy a house, but what about private mortgage insurance (PMI)? Do you have to get it? How much does it cost? Can you get rid of it? 

PMI might seem confusing initially, but it’s quite common and it doesn’t always last forever. Here’s what you need to know. 

Why do I need to pay for private mortgage insurance? 

If you’re putting down less than 20% on a conventional loan (a mortgage backed by a private company rather than the government), you’ll likely need to pay for PMI. 

PMI exists to protect the lender in the event you stop making mortgage payments. The smaller your down payment, the more financial risk the lender takes on if you default. 

Additionally, a borrower with a 20% down payment has a bigger stake in the property, and is generally considered less likely to default than a buyer who might make the minimum down payment required.  

While PMI is associated with an added cost (more on that soon), it’s often a worthwhile price to get your foot in the door of homeownership. With median home prices reaching an all-time high of $428,700 in Q1 2022, most Americans might struggle to afford a 20% down payment.    

In fact, in 2021, first-time buyers put down an average of 6%-7%, while repeat buyers made an average down payment of 17%. With a conventional loan, it may be possible to put down a lower down payment. A lower down payment backed by mortgage insurance can make homeownership possible sooner. 

Note that government-backed loans — such as Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA), and U.S. Department of Veterans Affairs (VA) loans — have their own mortgage insurance rules.

How much does PMI cost? 

The cost of PMI can vary based on a variety of buyer financial factors. Though most buyers will generally pay somewhere between 0.5% and 1% annually. This cost (known as a “premium”) is usually included in monthly mortgage payments, spread out across the year.

So how much will you end up paying each month? Let’s look at an example of a buyer borrowing $300,000 for a new house.

PMI percentage: 0.19% -> Cost per year: $570 -> Cost per mortgage payment: $47.50

PMI percentage: 0.5% -> Cost per year: $1,500 -> Cost per mortgage payment: $125

PMI percentage: 1% -> Cost per year: $3,000 -> Cost per mortgage payment: $250

PMI percentage: 1.86% -> Cost per year: $5,580 -> Cost per mortgage payment: $465

As you can see, PMI cost can make a pretty big impact on your monthly mortgage payment and overall housing budget. 

A few factors that may affect PMI cost:

• Credit score: A better credit score could get you a lower PMI payment, while a lower credit score usually means a higher PMI payment.

• Down payment amount: The closer you get to a 20% down payment, the less you’ll probably pay in PMI. That means a buyer with 3% down will probably pay more for PMI than a buyer with 15% down.  

• Loan amount: With a larger loan amount, you may pay more in PMI. 

• Loan type: An adjustable-rate loan (a less common type of mortgage with a lower introductory rate that “adjusts” with market rates over time) may require a higher cost PMI. Fixed-rate loans tend to carry less risk to the lender, so PMI costs are often lower. 

• Individual lender: PMI fees can vary from lender to lender.

When can I stop paying PMI?

The good news is, PMI payments usually don’t go on forever. 

When you reach 20% equity (that’s your stake in the property vs. your lender’s stake), you can ask your lender to drop PMI. It will depend on your specific loan, but, generally, they are required by law to do so when you reach 20% equity based on original value, as long as you are current on your mortgage payments and meet certain payment history requirements. You may also be required to demonstrate that the property hasn’t declined in value and that the equity is not subject to a second lien.

It’s important to note that you must initiate the request to drop PMI when you reach 20% equity. Otherwise, in many cases, the lender will drop your PMI automatically when you reach 22% equity if you are current on your mortgage payments. 

The final way to drop PMI is also initiated by the lender. It happens after you’ve hit the midpoint of your mortgage repayment schedule if, on that date, you are current on your mortgage payments, even if you haven’t gotten to 22% equity yet. 

The bottom line? Once you reach 20% equity, you can request removal of PMI. Otherwise, your lender will likely remove it — eventually. 

You can figure out when you’ll be ready to drop PMI by looking at your loan repayment schedule.    

What if your property gains value?

Paying down your loan isn’t the only way to gain equity. You may also make home improvements, and sometimes home values go up without you doing anything at all. Depending on your specific loan, here’s how you may be able to get PMI canceled if you reach 20% equity before your loan schedule dictates:

• Home improvements: If you significantly increase the value of your home with improvements, you can often drop PMI when you reach 20% equity. You’ll need to show the lender evidence that you’ve made substantial improvements (such as structural alterations, new appliances, or adding new components like HVAC) that substantially extend the useful life of your home and conform to local zoning and building codes.

• Property value increases: Sometimes your property value goes up for reasons that are outside your control. In this case, you may be able to drop PMI, but there are a few rules to keep in mind. If your loan is less than 2 years old, you can’t drop PMI for a property value increase. If your loan is between 2 and 5 years old, your equity will need to be at least 25% to drop PMI. If your loan is 5 or more years old, you can drop PMI at 20% equity.

In either situation, you’ll need to pay for a proper assessment of value, such as a broker price opinion (BPO) or appraisal to prove to the lender you’ve reached the proper equity level. You’ll also need to be up-to-date and in good standing on your mortgage payments.  

Is there a way not to pay PMI? 

Hoping to avoid PMI all together, but don’t have 20% to put down? You may have a few options. But it’s important to understand that there are very few scenarios where you can make a smaller down payment and pay nothing to cover the lender’s added risk. In most cases, you’ll pay something. 

Conventional loans 

With conventional loans, there are five main options to avoid paying for PMI:

1. 20% down payment: Make a 20% down payment and, in most cases, you can avoid PMI altogether. 

2. Borrower-paid PMI: Make a down payment that’s less than 20% and get the typical borrower-paid PMI, spread out across your monthly mortgage payments until you reach 20% equity.

3. Pay PMI upfront: Make a down payment that’s less than 20% and, in some cases, you can pay your entire PMI cost upfront, essentially removing it from your mortgage payments. In this case, you’d still pay PMI, but in one lump sum instead of over time. 

4. Lender-paid PMI: Make a down payment that’s less than 20%, and request lender-paid PMI. The lender would cover your entire PMI policy in one lump sum at closing, and in exchange you’ll pay a higher interest rate. This may save you money over borrower-paid PMI, but it depends on how long you’ll be in the home. And remember, with this option, you can’t cancel PMI because you make improvements or your home’s price goes up. You’re typically stuck with the policy being baked into your interest for the life of the loan, until you sell or refinance. Note that not all lenders offer lender-paid PMI.

5. Piggyback loan: Another option might be to take out a second mortgage, often called a piggyback loan, to get you over the 20% down payment threshold. Basically, you would put down 10%, and take out a second mortgage for an additional 10% to avoid PMI. However, you’d have to make two mortgage payments, and you’ll usually pay a higher interest rate on the second mortgage than the first. So you’ll need to weigh if this option truly helps your budget. 

Keep in mind, too, that not all lenders offer each of these options. Some lenders may not offer lender-paid PMI, or even the option to prepay your PMI. Make sure to ask any would-be lenders what PMI options they offer, and how to qualify for each.

Government-backed loans

Government-backed loans, such as FHA loans, can be popular with buyers who may not qualify for a conventional loan. These loans usually have more flexible credit requirements along with low down payment requirements. However, as mentioned above, these loans have their own mortgage insurance rules, and some of these loans also may have substantial mortgage insurance fees to cover the additional risk.  

Wrapping up

PMI is usually required if you’re using a conventional loan and making a down payment that’s less than 20%. It generally costs between 0.5% and 1% of the loan amount annually. You may have a few different payment options, like paying for your policy upfront, or asking the lender to cover it in exchange for a higher interest rate. Ultimately, though, you shouldn’t be stuck with PMI forever, and you can usually drop it once you reach 20% equity in the home. 

This content is meant for informational purposes only and is not intended to be construed as financial, tax, legal, or insurance advice. Opendoor always encourages you to reach out to an advisor regarding your own situation.