Understanding PMI on a Conventional Loan: Costs and Cancellation

When you buy a home with a conventional loan and put down less than 20 percent, you'll need private mortgage insurance (PMI). This extra cost protects the lender if you default on your mortgage. Many homebuyers wonder about PMI cost and how it affects their monthly payments.

PMI adds to your mortgage payment each month. The amount depends on your loan details, credit score, and down payment size. Understanding PMI on a conventional loan helps you plan your budget and explore ways to reduce or eliminate this expense.

What is PMI?

PMI stands for private mortgage insurance. This type of insurance protects your mortgage lender if you can't make your mortgage payments. The borrower pays for PMI, but it only benefits the lender.

Private mortgage insurance is required when you put down less than a 20 percent down payment on a conventional mortgage. The insurance company pays the lender if you default on your mortgage. This protection lets lenders offer loans to borrowers with smaller down payments.

PMI differs from homeowners insurance, which protects your property. PMI is a form of mortgage insurance that only covers the lender's risk. You pay the PMI premium as part of your monthly mortgage payment.

How Much is PMI on a Conventional Loan?

PMI costs typically range from 0.2% to 2% of your original loan amount per year. Most borrowers pay between 0.5% and 1% annually. The exact cost of PMI depends on several factors.

For example, if you borrow $300,000, your annual PMI premium might be $1,500 to $3,000. This breaks down to $125 to $250 added to your monthly mortgage payment.

Your lender will tell you the exact PMI rate before you close on your loan. Rocket Mortgage and other lenders provide PMI calculators to estimate your costs. The PMI payment becomes part of your mortgage payment until you can cancel PMI.

Factors That Affect PMI Cost

Several factors determine how much you pay for PMI:

Credit Score: Borrowers with higher credit scores pay less for PMI. A credit score above 740 typically gets the best PMI rates. Lower credit scores mean higher PMI costs.

Down Payment Amount: The less you put down, the more you pay for PMI. A 5% down payment costs more than a 15% down payment. Borrowers who put down less than a 20 percent down payment must pay for PMI.

Loan Amount: Larger loans mean higher PMI costs. The insurance rates apply to your total loan amount.

Loan Term: 30-year loans often have different PMI rates than 15-year loans. Your loan term affects the PMI premium calculation.

Property Type: Single-family homes typically have lower PMI rates than condos or investment properties. The type of property influences your PMI costs.

PMI Companies

The following companies display their PMI rates.

Essent Guaranty
Arch Mortgage Guaranty Company
Enact MI
Essent Guaranty, Inc.

How is PMI Calculated?

The first step in calculating the PMI is to find the correct rate factor. In this example, we'll use 0.0055. The loan amount is then calculated by the rate (.0055). As you can see below, the annual cost is the divided by 12 (months). This calculation assummes monthly PMI, the most popular plan.

Annual PMI:
285,000×0.0055=1,567.50 per year- Monthly PMI:
1,567.50÷12=$130.63 per month

Your estimated PMI is $130.63/month with a 0.55% rate on a $285,000 loan.

The previous example was based on a 700 credit score with a 10% down payment.

See Arch Mortgage Insurance Company for a complete listing of PMI rates for the moonthly premium plan.

Types of PMI

Conventional loans offer several types of mortgage insurance options:

Borrower-Paid PMI: The most common type where you pay PMI monthly. This PMI payment is part of your monthly mortgage payment. You can cancel this type when you reach 20% equity.

Lender-Paid PMI: The lender pays the PMI premium upfront and charges you a higher interest rate. You avoid a separate PMI payment, but you can't cancel this arrangement.

Single-Premium PMI: You pay the entire PMI premium at closing. This eliminates monthly PMI payments but requires more cash upfront. You lose this payment if you refinance early.

Split-Premium PMI: A combination where you pay part upfront and part monthly. This reduces your monthly payment compared to borrower-paid PMI.

When is PMI Required?

PMI is required for conventional loans when your down payment is less than 20 percent of the home's value. All conventional loans with lower down payments must include private mortgage insurance.

The PMI requirement protects the lender against losses if you default. Without PMI, lenders wouldn't offer loans with small down payments. This insurance makes homeownership possible for borrowers who can't save 20% down.

Some loan programs don't require PMI. VA loans for veterans and USDA loans for rural areas don't need mortgage insurance. FHA loans require mortgage insurance but use different rules than conventional loans.

How to Stop Paying PMI

You can get rid of PMI once you build enough equity in your home. Here are the main ways to eliminate PMI:

Automatic Cancellation: Your lender must automatically cancel PMI when your mortgage balance reaches 78% of the original home value. This happens naturally as you pay down your loan.

Request Cancellation: You can request to cancel PMI when your balance drops to 80% of the original home value. You'll need to contact your lender and may need a new appraisal.

Refinancing: A new mortgage can eliminate PMI if your home's value increased enough to give you 20% equity. This works best when interest rates are favorable.

Extra Payments: Making additional payments toward your mortgage principal reduces your balance faster. This helps you reach the 80% threshold sooner.

How to Avoid Paying PMI

Several strategies can help you avoid PMI altogether:

20% Down Payment: The most direct way to avoid PMI is putting down 20% or more. This eliminates the PMI requirement entirely.

Piggyback Loan: A second mortgage covers part of your down payment. For example, you might get an 80% first mortgage, 10% second mortgage, and put 10% down. This avoids PMI but means two mortgage payments.

VA or USDA Loans: These government-backed loans don't require PMI. VA loans serve veterans, while USDA loans help rural homebuyers.

Lender Credits: Some lenders offer credits to cover PMI costs. They might charge a higher interest rate in exchange for paying your PMI premium.

Conventional vs FHA Loans and PMI

Conventional loans and FHA loans handle mortgage insurance differently. Understanding these differences helps you choose the right loan type.

FHA loans require mortgage insurance for the life of the loan in most cases. You can't cancel FHA mortgage insurance like you can with PMI on conventional loans. This makes conventional loans better for long-term savings.

Conventional loans let you cancel PMI when you reach 20% equity. FHA loans require refinancing to eliminate mortgage insurance. This flexibility makes conventional loans more attractive for many borrowers.

The cost difference varies by situation. FHA loans might have lower insurance rates for borrowers with poor credit. Conventional loans often cost less for borrowers with good credit scores.

PMI and Your Monthly Payment

PMI adds a significant cost to your monthly mortgage payment. A typical borrower might pay $100 to $300 monthly for PMI. This extra amount affects your buying power and monthly budget.

When calculating affordability, include PMI in your total housing payment. Add your principal, interest, property taxes, homeowners insurance, and PMI. This gives you the complete picture of your monthly costs.

Remember that PMI is temporary for conventional loans. Once you build equity, you can eliminate this expense. This makes your mortgage payment more affordable over time.

Is PMI Worth It?

PMI might seem like an added cost, but it serves a valuable purpose. Without PMI, you'd need to save 20% down before buying a home. This could take years of additional saving.

PMI lets you buy a home sooner with a smaller down payment. You start building equity immediately instead of waiting. Home values often rise over time, helping you build wealth faster.

The pros and cons of PMI depend on your situation. If home prices are rising quickly, buying sooner with PMI might save money. If you can save 20% down quickly, avoiding PMI might be better.

Shopping for the Best PMI Rates

Different lenders offer different PMI rates for the same borrower. Shopping around can save you money on your mortgage insurance premium.

Compare PMI costs from multiple lenders when getting mortgage quotes. Ask about all types of PMI options, not just monthly payments. Some lenders offer better single-premium or lender-paid options.

Your mortgage broker can help you find competitive PMI rates. They work with multiple lenders and can compare your options. This saves time and potentially money on your PMI costs.

PMI Tax Deductions

PMI used to be tax-deductible like mortgage interest. However, this deduction expired and may not be available. Check with a tax professional about current PMI deduction rules.

Even without tax benefits, PMI serves an important purpose. It makes homeownership possible with smaller down payments. The temporary nature of PMI on conventional loans keeps long-term costs manageable.

Planning for PMI Removal

Start planning to eliminate PMI from the beginning of your loan. Track your mortgage balance and home value to know when you can cancel PMI.

Consider making extra payments toward your mortgage principal. This reduces your balance faster and helps you reach the 80% loan-to-value ratio sooner. Even small extra payments can save years of PMI payments.

Monitor your home's value through neighborhood sales and online tools. If your home appreciates significantly, you might qualify for PMI removal through a new appraisal. This works especially well in rising markets.

Understanding PMI on a conventional loan helps you make informed decisions about your mortgage. While PMI adds to your monthly costs, it makes homeownership possible with smaller down payments. Plan to eliminate PMI as soon as possible to maximize your savings over the life of the loan.

Frequently Asked Questions About PMI

Is PMI Tax Deductible?

The federal tax deduction for PMI has expired and, as of this writing, has not been reinstated. You should consult with a qualified tax advisor for the most current information regarding any potential tax benefits.

Can I Remove PMI After a Home Renovation?

Yes, if a renovation significantly increases your home's value, you can get a new appraisal. If the appraisal shows your loan balance is 80% or less of the new value, you can request PMI cancellation. Programs like the Fannie Mae HomeStyle Renovation loan are designed for this purpose.

What Happens to PMI When I Refinance?

When you refinance your mortgage, your original loan is paid off, and with it, the PMI obligation. Your new loan will have its own requirements. If you have less than 20% equity in the new loan, you will likely need a new PMI policy. For those with significant equity, a cash-out refinance might be an option.

Does PMI Cover Me as the Homeowner?

No. A common misconception is that PMI protects the borrower. It does not. It only protects the lender from financial loss if you foreclose. You will still need a separate homeowners insurance policy to protect your own investment in the property.

Making an Informed Decision on PMI

Private mortgage insurance is a powerful tool that enables homeownership with a smaller down payment. While it adds an immediate cost, its temporary nature and the ability to cancel it make it a strategic choice for many buyers. By understanding the costs, types, and cancellation rules, you can effectively plan your path to homeownership and eventually eliminate this expense, reducing your overall monthly payment on a conventional loan.