Understanding PMI: What It Is and Why You Might Need It for Your Mortgage

When buying a home, there are many financial terms and concepts to grasp, and one that often comes up is Private Mortgage Insurance (PMI). If you're in the process of securing a mortgage or planning to in the future, understanding PMI is crucial. Here’s what it is and why you might need it for your mortgage.

What Is PMI?

Private Mortgage Insurance, or PMI, is a type of insurance that protects the lender in case you, the borrower, default on your loan. It’s typically required by lenders when you’re unable to make a large down payment on your home—usually when you put down less than 20% of the home’s purchase price.

If you’re unable to put down a 20% down payment, lenders view you as a higher risk. PMI is one way they can mitigate that risk and ensure they don’t suffer a financial loss if you were to default on the loan.

Why Do You Need PMI?

PMI benefits the lender by offering them protection if you’re unable to keep up with your mortgage payments. While it may feel like an added expense, PMI allows you to qualify for a mortgage with a smaller down payment.

Here’s why PMI can be necessary:

• Lower Down Payment: PMI enables buyers to purchase homes with a down payment as low as 3%, 5%, or 10%. Without it, lenders would be more hesitant to approve a loan with a smaller down payment because it poses a higher risk of default.

• Faster Path to Homeownership: PMI opens the door to homeownership for those who may not have the ability to save for a 20% down payment, allowing them to get into their homes sooner rather than waiting years to save more.

How Does PMI Work?

PMI is usually added to your monthly mortgage payment, but it can also be paid as a one-time premium or as a combination of both upfront and monthly payments. The cost of PMI varies depending on the size of your down payment and the type of loan you have.

The premiums for PMI generally range from 0.3% to 1.5% of the original loan amount per year. For example, if you have a $200,000 loan and your PMI rate is 1%, you’d pay about $2,000 annually, or approximately $167 per month, in PMI premiums.

How Can You Avoid PMI?

While PMI can be a helpful tool for securing a mortgage with a smaller down payment, it’s not always desirable because of the extra cost. Here are a few strategies that might help you avoid PMI:

• Make a Larger Down Payment: The most straightforward way to avoid PMI is to save enough money to put down at least 20% of the home’s purchase price.

• Piggyback Loan: Some buyers use a "piggyback" loan strategy, where they take out two loans: one for 80% of the home’s value and another for the remaining 10% or 15%. This can help avoid PMI, but keep in mind that second loans often come with higher interest rates.

• Look into Lender-Paid PMI: In some cases, lenders may offer "lender-paid" PMI, where they cover the cost of PMI, but in exchange, you may receive a slightly higher interest rate on your mortgage.

How Long Will You Need PMI?

The good news is that PMI isn’t necessarily a permanent fixture of your mortgage. In fact, once you’ve built enough equity in your home (usually when you’ve paid down the loan balance to 80% of the home’s original appraised value), you can request to have PMI removed.

Additionally, under the Homeowners Protection Act (HPA), lenders are required to automatically cancel PMI when your loan balance reaches 78% of the home’s original value, as long as you’re current on your mortgage payments.

Private Mortgage Insurance (PMI) is an insurance policy that protects the lender if you default on your loan, and it’s typically required if your down payment is less than 20%. While it’s an added expense, it allows you to buy a home with a smaller down payment and can help you get into your home sooner. Understanding PMI, how it works, and how to potentially avoid or remove it can help you make informed decisions when securing your mortgage.

If you’re not sure whether you need PMI or how it will impact your mortgage, it’s always a good idea to talk with your lender or mortgage broker to understand all your options.