When buying a home with less than 20% down, Private Mortgage Insurance (PMI) often becomes part of the equation. PMI is an additional cost that protects lenders if you default on your loan, but it can significantly impact your monthly budget.
Understanding how PMI works, what it costs, and the strategies for managing or avoiding it can help you make smarter financial decisions as a homeowner.
This guide explores the true cost of PMI, tips for budgeting, and advanced strategies for reducing or eliminating PMI over time. We’ll also review flexible options available with conventional loans, such as Lender-Paid Mortgage Insurance (LPMI) and single-premium PMI, to help you find the best solution for your financial goals.
What Does PMI Really Cost?
PMI costs vary depending on your loan amount, down payment, credit score, and loan type. On average, PMI costs between 0.3% and 1.5% of your loan amount annually.
PMI is based on two primary factors: 1.) Your down payment and 2.) Your credit score. Here’s an example from a major private mortgage insurance company:
Here you can see that the bigger down payment and better your credit score, the cheaper your mortgage insurance will be.
For example:
- A $300,000 loan for a buyer with a 660 credit score and 5% down would be $302.50/month ($300,000 * .0121 = $3,630/12 months = $302.50)
- A $300,000 loan for a buyer with a 760 credit score and 10% down would be $75/month ($300,000 * .003 = $3,630/12 months = $75)
That’s a substantial difference in the monthly payment! Understanding these factors can help you budget and plan more effectively.
[Related Reading: The Role of Credit Scores in Mortgage Approval: How Lenders Evaluate Risk]
How to Budget for PMI
Factoring PMI into your housing budget is crucial for avoiding financial strain. Here are some practical tips:
1. Include PMI in Your Monthly Payments
Calculate your total housing payment, including principal, interest, property taxes, homeowners insurance, and PMI. For example:
- Estimated Mortgage Payment: $1,200 (principal and interest).
- PMI Premium: $100.
- Total Housing Cost: $1,300 per month.
Ensure this fits comfortably within 28-30% of your gross monthly income.
2. Shop Around for Lenders
While PMI rates aren’t directly negotiable, lenders may offer different options based on different MI companies. Compare lenders to find the most competitive PMI rates.
3. Plan for the Long Term
On conventional loans, PMI isn’t permanent. Budget for it over the first few years of your mortgage, but develop a strategy to remove it once you reach 20% equity.
[Related Reading: How Much Mortgage Can I Afford? Understanding Your Budget and Avoiding Being House Poor]
How to Drop PMI
One of the biggest advantages of PMI on conventional loans is that it can be removed as you build equity in your home. Here are three common methods for reducing or eliminating PMI:
1. Reach 20% Equity
When your loan balance drops below 80% of your home’s original value, you can request PMI cancellation.
- Action Step: Contact your lender to initiate the cancellation process. An appraisal may be required to confirm your home’s current value.
2. Refinance Your Mortgage
Refinancing can help eliminate PMI if your home has appreciated in value or if you’ve paid down your loan to 80% LTV. However, refinancing comes with closing costs, so weigh the savings against these expenses. Also, make sure the interest rate makes sense – going from a lower rate to a higher rate just to drop PMI can be counterintuitive and cost you money in the long run.
3. Automatic Cancellation
By law, lenders must cancel PMI automatically when your loan balance reaches 78% of the original home value, provided you’re current on payments. This safeguard prevents overpayment.
[Related Reading: choosing-the-right-loan-term]
Flexible PMI Options with Conventional Loans
Conventional loans offer flexibility for managing PMI costs, allowing borrowers to choose alternatives to traditional monthly premiums. Here are three advanced strategies:
1. Lender-Paid Mortgage Insurance (LPMI)
With LPMI, the lender pays the PMI premium on your behalf. In return, you’ll pay a slightly higher interest rate on your mortgage.
Pros:
- No separate monthly PMI payment.
- Simplifies budgeting.
- Don’t have to worry about dropping PMI down the road
Cons:
- Slightly higher interest rates increase overall loan costs.
- Not ideal for long-term homeowners.
2. Single-Premium PMI
Single-premium PMI allows you to pay the entire PMI cost upfront at closing. This is a line item closing cost reflected on the Loan Estimate and Closing Disclosure.
Pros:
- Eliminates monthly PMI payments.
- Can save money over time if you stay in the home long-term.
Cons:
- High upfront cost.
- May not be refundable if you sell or refinance early.
3. Single-Premium Financed PMI
Some lenders allow you to finance this into your mortgage if you have a down payment of 10% or more.
Pros:
- Avoids a large upfront expense.
- Reduces monthly payments compared to traditional PMI.
Cons:
- Increases your loan balance and interest payments.
- If rates are high, you could end up paying more over a long period of time
[Related Reading: What is PMI? A Beginner’s Guide to Understanding Private Mortgage Insurance]
Advanced Strategies for Avoiding PMI
Avoiding PMI altogether is possible with careful planning and the right loan type. Consider these strategies:
1. Save for a Larger Down Payment
A 20% down payment eliminates the need for PMI entirely. While this may take time, it can save you thousands of dollars over the life of your loan.
2. Consider Piggyback Loans
A piggyback loan involves pairing a second mortgage with your home purchase to cover part of your down payment. This reduces your first mortgage’s loan-to-value to below 80%, so PMI isn’t required. For example:
- Primary Loan: Covers 80% of the home price.
- Secondary Loan: Covers 10%.
- Down Payment: 10% from your savings.
Note: As the monthly cost of PMI has decreased over time for high credit borrowers, this option has become less popular. Having a second mortgage is considered a loan level price adjustment, so this piggyback strategy can result in a higher interest rate.
Final Thoughts
PMI may feel like an unavoidable cost for many homebuyers, but understanding its role and exploring advanced strategies can help you manage or even avoid it effectively. By budgeting for PMI, building equity to remove it, or considering flexible options like LPMI or single-premium PMI, you can reduce its impact on your finances.
Ultimately, choosing the right PMI strategy depends on your financial goals, how long you plan to stay in your home, and your overall budget. Taking the time to weigh your options and work with your lender will set you on the path to smart and sustainable homeownership.
For more insights, explore these related articles:
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