What is PMI? How private mortgage loan insurance works

Buying a home usually presents a monster obstacle: finding a sufficient down payment. The amount you put on a conventional mortgage – which is not guaranteed by the federal government – will determine whether you need to purchase PMI insurance or private mortgage insurance.

Typically, a lender will ask you to buy PMI if you deposit less than the traditional 20%.

What is private mortgage insurance?

PMI is insurance for the benefit of the mortgage lender, not yours. You pay a monthly premium to the insurer and the coverage will pay a portion of the balance owed to the mortgage lender in the event of a mortgage default.

Insurance doesn’t prevent you from facing a foreclosure or seeing your credit score drop if you fall behind on mortgage payments.

PMI is insurance for the benefit of the mortgage lender, not yours.

The lender needs PMI because they take on additional risk by accepting a lower amount of initial money for the purchase. You can avoid PMI by making a deposit of 20%.

Mortgage insurance for FHA loans, supported by the Federal Housing Administration, works a little differently from PMI for conventional mortgages. VA loans, backed by the US Department of Veterans Affairs, do not require mortgage insurance, but do include a “finance charge”. USDA mortgages, backed by the US Department of Agriculture, have upfront and annual fees.

What is the PMI?

The average annual cost of the PMI typically ranges from 0.58% to 1.86% of the original loan amount, according to Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute.

These averages were calculated using a mortgage of $ 241,250 – the loan balance you would have if you bought a house for $ 250,000 and made a 3.5% down payment.

At these rates, the PMI could cost anywhere from $ 1,399 to $ 4,487 per year, or about $ 117 to $ 374 per month.

The cost of private mortgage insurance depends on several factors:

  • The size of the mortgage. The more you borrow, the more you pay for PMI.

  • Deposit amount. The more money you put into the house, the less you pay for the PMI.

  • Your credit score. PMI will cost less if you have a higher credit score. In general, you will see the lowest PMI rates for a credit score of 760 or higher.

  • The type of mortgage. PMI can cost more for a variable rate mortgage than a fixed rate mortgage. Since the rate can increase with a variable rate mortgage, the loan is riskier than a fixed rate loan, so the PMI is likely higher.

Typically, the PMI cost, known as the “premium”, is added to your monthly mortgage payment. You can see the premium on your loan estimate and closing disclosure mortgage documents in the “projected payments” section.

Sometimes lenders offer the option of paying the PMI cost as a single initial premium or with a combination of initial and monthly premiums.

Is the PMI tax deductible?

Private mortgage insurance is currently tax deductible. Congress extended the tax deduction for mortgage insurance premiums, which expired at the end of 2017, until the end of 2020.

The amount paid for private mortgage insurance is treated as mortgage interest on your tax return. To claim the deduction for the 2020 tax year, the insurance contract must have been issued after 2006.

The amount you can deduct is reduced and can be eliminated if your adjusted gross income is greater than $ 100,000 ($ 50,000 if you are married but filed separately) on Form 1040 or 1040-SR, line 8b.

You cannot deduct mortgage loan insurance premiums if your adjusted gross income is more than $ 109,000 or $ 54,500 if you are married but filing separately.

When can you stop paying PMI?

Once your mortgage balance is less than 80% of the original appraised value or the current market value of your home, whichever is less, you can usually get rid of PMI. There are often additional requirements, such as a history of timely payments and the absence of a second mortgage.

Frequently Asked Questions

PMI stands for Private Mortgage Insurance, a type of insurance policy that protects the lender in the event a borrower defaults on a home loan. Lenders usually require you to pay the PMI if you put less than 20% conventional mortgage.

You can avoid PMI without paying a deposit of 20%. With a Loan 80-10-10, also known as a piggyback loan, you make a 10% down payment and have two mortgages that cover the remaining 90%. Although rare, some lenders offer mortgage insurance paid for by the lender. The trap? You will pay a higher interest rate to help cover the costs.

Yes your credit score affects the cost of private mortgage insurance. A borrower with a higher credit score would likely pay a lower monthly premium for PMI than someone with a lower credit score, even with the same down payment and the same mortgage amount.

Paying for private mortgage insurance adds to your monthly mortgage payment, but it doesn’t have any negative effects beyond costing you additional cash. On the plus side, PMI can let you buy a home – and start building home equity – faster than if you waited until you had saved a 20% deposit.

No, the PMI does not decrease over time. However, if you have a conventional mortgage, you can cancel PMI once your mortgage balance equals 80% of the value of your home at the time of purchase.

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