Private Mortgage Insurance (PMI) is the cost of going below 20% down on a conforming loan. For loan balances above the conforming limit (the “Jumbo” tier most readers of this book end up in), PMI is typically not the operative constraint — see section “Jumbo Loan Microstructure” for the underwriting reality that replaces it. If you are buying within conforming limits with a small down payment, the rest of this subsection applies directly.
PMI is a type of insurance that lenders require from homebuyers who obtain conventional loans with a down payment of less than 20% of the home’s purchase price. PMI protects the lender in case the borrower defaults on the loan. PMI protects lenders if borrowers default on their loans. It allows buyers who can’t or won’t make large down payments to secure mortgage financing at affordable rates. PMI is common in “high-ratio” loans, where the loan-to-value (LTV) ratio exceeds 80%. It helps lenders recover costs from foreclosed property resales, including accrued interest, taxes, and insurance paid before resale.
PMI mitigates the risk for lenders when borrowers have less equity in the property. If you default, the insurance compensates the lender for losses.
PMI typically costs between 0.3% to 1.5% of the original loan amount per year. For a $1,000,000 loan, this could range from $3,000 to $15,000 annually.
PMI can be paid monthly, as a one-time upfront premium, or a combination of both. Monthly payments are the most common.
While PMI can increase monthly payments, it enables homeownership sooner, which can be beneficial in appreciating markets. Avoiding PMI can save you significant money over the life of your loan. Few options:
The most straightforward way to avoid PMI is to make a down payment of at least 20% of the home’s purchase price. This demonstrates sufficient equity and reduces the lender’s risk.
Also known as an 80-10-10 loan, this involves taking out a second mortgage to cover part of the down payment. This structure typically includes: a 10 percent down payment, 80 percent main mortgage, and a 10 percent “piggyback” second mortgage. In this scenario, you still borrow 90% of the home’s value, but the main mortgage covers only 80%. The second mortgage usually carries a higher, often adjustable, interest rate. These loans help you avoid PMI but come with risks and costs, such as higher interest rates on the second mortgage. Refinancing can be trickier because the second mortgage lender must agree to the refinance unless you can pay off the second mortgage with the new loan. The piggyback structure was common during the mortgage boom in the early to mid-2000s. CFPB provides guidance on this approach.
Some lenders offer LPMI, where they pay the PMI in exchange for a slightly higher interest rate on the loan. This can be beneficial if you plan to stay in the home for a shorter period, as the higher interest rate may cost less over time than monthly PMI payments.
If you’re a veteran, you may qualify for a VA loan, which doesn’t require PMI regardless of the down payment amount. This is a significant benefit for eligible borrowers.
Once you have at least 20% equity in your home, you can refinance your mortgage to eliminate PMI. This can be a cost-effective strategy if interest rates are favorable.
The Homeowners Protection Act of 1998 (HPA or PMI Cancellation Act) was signed into law on July 29, 1998, and became effective on July 29, 1999. It was amended on December 27, 2000, for technical corrections and clarification. The Act addresses homeowners’ difficulties in canceling PMI coverage. It establishes provisions for canceling and terminating PMI, sets disclosure and notification requirements, and mandates the return of unearned premiums.
The Dodd-Frank Act granted the CFPB the authority to supervise and enforce compliance with the Homeowners Protection Act for entities within its jurisdiction.
You can request your lender to cancel PMI when your mortgage’s principal balance reaches 80% of your home’s original value. The earliest date for this request is listed on your PMI disclosure form, which you received with your mortgage. If you can’t locate the form, contact your servicer.
Additionally, you can request PMI cancellation earlier if you’ve made extra payments that reduce your mortgage’s principal balance to 80% of your home’s original value.
For more detailed information, refer to the CFPB guidelines on PMI.