Private Mortgage Insurance (PMI) Cost and How to Avoid Them

When you apply for a mortgage, the lender may require a down payment of 20% of the home's purchase price. Many mortgages do offer buyers the opportunity to put down a lower amount, but you will have to pay for mortgage insurance.

PMI protects the lender in the event that you default on your primary mortgage and the home goes into foreclosure. When you put down a lower amount, a lender will consider the loan as a riskier investment and require that the homebuyer buy private mortgage insurance (PMI) with a premium that will be included in the monthly mortgage payments.

How PMI Works

One of the measures of risk that lenders use in underwriting a mortgage is the loan's loan-to-value (LTV) ratio. LTV is the ration of the amount of the loan to the value of the home. Most mortgages with an LTV ratio greater than 80% require that the borrower have PMI as they are considered more likely to default on a loan.

PMI is usually paid monthly as part of the overall mortgage payment to the lender, but sometimes it is paid as a one-time, up-front premium at closing. PMI isn't permanent—it can be dropped once a borrower pays down enough of the mortgage's principal.

Provided a borrower is current on their payments, their lender must terminate PMI on the date the loan balance reaches 78% of the original value of the home (in other words, when the equity reaches 22%). A borrower who has paid enough towards the principal amount of the loan (the equivalent of that 20% down payment) can contact their lender and request that the PMI payment be removed.

The Cost of PMI

PMI costs can vary, typically between 0.5% and 2.25% of the entire mortgage loan amount annually, depending on factors like the size of the loan and your credit score. PMI costs can raise a mortgage payment significantly. Let's say, for example, that you had a 1% PMI fee on a $200,000 loan. That fee would add approximately $2,000 a year, or $166 each month, to the cost of your mortgage.

This cost may be a good reason to avoid taking out PMI, along with the fact that canceling can be complicated. However, for many people PMI is crucial to buying a home, especially for first-time buyers who may not have saved up the necessary funds to cover a 20% down payment. Paying for this insurance could be worth it in the long run for buyers eager to own their own home.

Since PMI is designed to protect the lender, it will not protect you, the borrower, if you fall behind on your payments and you could still lose your home to foreclosure.

How to Avoid Paying PMI

If a homebuyer doesn't have the funds for a 20% down payment, it's possible to avoid PMI by taking out two loans—a smaller loan (typically at a higher interest rate) to cover the amount of the 20% down, plus the main mortgage. This practice is commonly known as piggybacking.

Although the borrower is committed to two loans, PMI is not required since the funds from the second loan are used to pay the 20% deposit.

The Bottom Line

PMI can be a costly necessity for homebuyers who don't have enough money saved for a 20% down payment. It may be possible to avoid PMI by taking out the main mortgage plus a smaller loan to cover the costs of a 20% down payment. However, for first-time homebuyers, PMI may be worth the extra money for the mortgage.