Private mortgage insurance, or PMI, is a type of insurance that helps protect lenders in the event that a borrower defaults on their mortgage loan. It’s usually required when a borrower puts down less than 20% of the home’s purchase price.
PMI can be expensive, and for most people it’s unnecessary. In this article, we’ll explain everything you need to know about PMI, how it works, and how to avoid paying for it.
When Do You Need to Carry PMI?
Private mortgage insurance is a type of insurance that helps protect lenders in the event that a borrower defaults on their mortgage loan. It’s usually required when a borrower puts down less than 20% of the home’s purchase price.
Do Private Mortgage Insurance Payments Build Equity?
No. Your monthly PMI payments do not go into an account that you can eventually tap into. It’s insurance for the lender, not for you. As a borrower, you’re paying for protection in case you default on your loan and the lender can’t otherwise recoup its losses.
What Does PMI Cover on a Mortgage?
In the event that a borrower defaults on their mortgage loan, PMI will help cover the balance of the loan. This doesn’t mean that the borrower won’t have to pay anything, but it does mean that the lender won’t be left high and dry for the entire balance.
How Long Do You Have to Carry PMI?
The length of time you have to carry PMI depends on a few factors, including the type of loan you have and the percentage of your down payment. In your mortgage documents, you’ll find a table that outlines when your lender will cancel your PMI.
For loans with fixed interest rates, you’ll usually have to carry PMI for two years. For adjustable-rate mortgages (ARMs), you may have to carry it for five years. However, each situation is unique, so be sure to check your mortgage documents.
How Much Does Private Mortgage Insurance Cost?
The cost of PMI varies, but it’s typically around 0.5% to 1% of the loan amount per year. So, on a $200,000 loan, you would pay $1,000 to $2,000 per year in PMI premiums. Factors that can affect your premium include the size of your down payment, the type of loan you have, and your credit score.
Do You Pay Interest on PMI?
Typically, you do not pay interest on your PMI premium. However, in cases where the lender allows some of the premium to be rolled into the loan, you will pay interest on that portion.
Can the PMI be Removed?
To get rid of the PMI requirement, your home’s equity needs to increase to 20% or more of the appraised value. For example, if your home is appraised at $200,000, you’ll need to have at least $40,000 in equity before you can cancel your PMI. You can also request that the lender remove the PMI once you’ve reached 20% equity.
Requesting a PMI Removal
If you have reached 20% equity in your home, you can request that your lender remove the requirement from your mortgage. In the lender disclosures, you should find an expected date you will reach 20% equity.
In some cases, you may need to provide proof of your home’s value, such as a recent appraisal or a home equity assessment. Once the PMI is removed, you’ll no longer have to pay the monthly premium. However, you will still be required to maintain insurance on your home.
Once your PMI is canceled, you may be entitled to a refund of a portion of your premium. This depends on when you purchased your home and when you reached 20% equity.
Can Refinancing Get Rid of PMI?
Yes. Refinancing your mortgage loan is one way to get rid of PMI premiums. It is not the only way, but it is often the most efficient and cost-effective method.
Is PMI Tax-Deductible?
Historically, PMI premiums have been tax-deductible. However, this IRS rule is reviewed annually and may change in the future. Be sure to speak with your tax preparer to see if you qualify for the deduction.
How to Avoid Paying Private Mortgage Insurance
When shopping for a mortgage, ask the lender about their PMI policy and what options are available to avoid paying PMI. With a little planning and forethought, you can save yourself thousands of dollars in unnecessary insurance premiums.
Some things you can do to avoid paying for private mortgage insurance include:
- Making a down payment of 20% or more – The higher your down payment, the less likely you are to default on your loan and the more equity you’ll have in your home.
- Choose a conventional loan product – FHA loans require borrowers to pay for PMI, but there are other loan products that do not.
- Find out your options – Ask your lender about avoiding PMI if you do not have the 20% down payment. There may be other options available to you, such as lender-paid mortgage insurance.
- Do your research – Be sure to compare different lenders and their policies before making a decision.
- Get a piggyback loan – A piggyback loan is a second mortgage that can be used to finance part of your down payment. This can help you avoid PMI, but it may come with a higher interest rate.
- Make extra payments – One way to quickly pay down your mortgage balance and reach 20% equity is to make extra payments. Every extra payment you make reduces your principal balance and helps you build equity faster.
- Choose a shorter loan term – A shorter loan term will also help you reach 20% equity faster. A 15-year mortgage will typically have a lower interest rate than a 30-year mortgage, but it will also be paid off much sooner.
As you can see, there are several ways to avoid paying private mortgage insurance. The best way to avoid PMI is to make a down payment of 20% or more when you purchase your home. However, there are other options available if you are not able to do this. Be sure to ask your lender about their PMI policy and what options are available to you.