What does mortgage insurance cover?
Private mortgage insurance is insurance for the mortgage lender and won't cover your home in any way. Lenders view a mortgage loan with a smaller down payment as a riskier investment, and mortgage insurance provides a safeguard for the lender if you default on the loan.
When do you have to pay PMI?
PMI must be paid as a condition of conventional mortgage loans if your down payment is less than 20%. For example, if the price of your new home is $200,000 and you're only able to pay $7,000 up front, then you pay PMI because your down payment is only 3.5% of your home's purchase price.
Down payment < 20% of the purchase price = PMI
Down payment > 20% of the purchase price = No PMI
How much is PMI?
PMI costs vary, depending on your loan type, but plan to pay between 1% and 3% of your home's purchase price. Let's say the purchase price is $200,000 and your down payment is $10,000. Assuming your annual percentage rate (APR) is 4% and the PMI rate is 2%, your mortgage insurance amount would be $317 per month.
How do PMI payments work?
PMI is usually included in your mortgage payment. You may choose to pay PMI in one lump sum at the start of your loan. Or, you can opt for your lender to cover your PMI, but that means a higher interest rate on your mortgage. Understand that if you select the lender-paid option, you may pay more interest on your loan than you would including PMI in your monthly mortgage payment or paying in full.
Can I choose the mortgage insurance company?
No. Because PMI protects the lender only, your lender gets to select the company that will provide mortgage insurance.
Mortgage insurance vs home insurance
Mortgage insurance doesn't cover you or your home. It's not a substitute for a home insurance policy, which protects the structure of your home, personal belongings, and your pocketbook in case you're financially liable for something. Home insurance is typically required by your lender no matter the size of your down payment and is highly recommended even after you pay off your home. Mortgage insurance, however, is only required if you're unable to make a 20% down payment on a new home loan or refinance.
If you're going through the home-buying process and have additional questions about insurance, check out our guide to home insurance for first-time buyers.
How to avoid PMI
Mortgage insurance covers your lender, not you. That makes it an expense you'll want to avoid, if possible. Below are a few ways you can avoid PMI, if you're able:
- Put 20% or more down: If you have a conventional loan, you won't have to pay PMI with a down payment of at least one-fifth of the home's purchase price.
- Take a second mortgage: Often referred to as “piggybacking,” you can cap your first mortgage at 80% of your home's value and use a second mortgage to finance the rest. Lenders usually require a down payment of at least 10% for this option.
- Choose a government-insured loan: If you're eligible for a VA loan, backed by the U.S. Department of Veteran Affairs, mortgage insurance isn't required. Same goes for USDA (United States Department of Agriculture) loans. Keep in mind, FHA loans require mortgage insurance.
- Cancel mortgage insurance when possible: Stay up to do date with your home's market value and monitor your mortgage balance. Once the balance of your loan falls below 80% of your home's value or purchase price, consider refinancing or contact your lender about eliminating PMI.