Your Options for Paying Private Mortgage Insurance

When you purchase a home with a down payment of less than 20%, or refinance your home with less than 20% in home equity, your lender will require you to pay private mortgage insurance (PMI).

You’re financing the home purchase with less skin-in-the-game when you make a smaller down payment, so mortgage lenders view these loans as slightly riskier than loans with an 80% or lower loan-to-value ratio. Your lender will reduce the risk to the financial institution and still be willing to approve a loan for you by requiring PMI, which is insurance that protects the lender in case you default on the loan.

PMI Payments

While PMI covers the lender, you will be required to pay the premiums. The amount you will pay is up to the PMI provider and will be based on your credit score and the loan-to-value ratio on the property you are purchasing. For example, someone with a credit score below 700 who makes a down payment of 5% will pay a higher premium than a borrower with a credit score of 760 who makes a down payment of 15%.

Your PMI payments will automatically be canceled when your loan-to-value ratio reaches 78% according to your loan amortization schedule; but if you pay extra to reduce your principal balance, your home rises in value over time, or you make significant improvements that increase its value, you can pay for an appraisal and request that your PMI be canceled earlier.

Options for Paying PMI

There are three common ways of paying PMI that most lenders offer. You can sometimes combine two of these options if you prefer.

§  Monthly payments: Most people pay PMI with their monthly mortgage to their lender. The lender then pays the PMI premium annually for you. PMI payments range from 0.3% to 1.15% of your loan amount. If you are buying a $200,000 home with 10% down, your loan amount will be $180,000. If your PMI rate is 1%, your annual premium would be $1,800 and your monthly PMI payment would be $150.

§  Lender-paid PMI: While “lender-paid” sounds like a good option, in reality you are paying the PMI premiums through a higher interest rate. Your monthly payments will be lower than if you had to pay monthly PMI payments, but your interest rate and interest payments will be a little higher than they would have been otherwise. In addition, you will keep that interest rate until you refinance or pay off your loan, but this method has the advantage of increasing your mortgage interest tax deduction.

§  Single premium PMI: If you have enough cash but prefer to keep your monthly payments as low as possible, you may want to pay your PMI premiums in a lump sum at the beginning of your loan. A single premium PMI policy typically requires a payment of 1% to 2% of your loan amount, so on that $180,000 loan you would pay between $1,800 and $3,600 at the settlement. You may also be able to wrap this single premium into your mortgage so it is financed over the 30-year loan period rather than on an annual basis.

Avoiding PMI

Some lenders, particularly credit unions, offer special loan programs for borrowers who want to make a down payment of less than 20% and still avoid PMI payments. In some cases, these loans have a slightly higher interest rate, so the lender is essentially self-insuring by charging a little more for the loan program.

During the housing boom, many lenders offered “80-10-10” or “80-15-5” financing, which meant that borrowers could take out both a first and second mortgage and make a down payment of 5% or 10% while still avoiding PMI. Some lenders offer these loans today to borrowers with excellent credit and a solid employment history.

While most borrowers don’t like the idea of paying PMI, this insurance offers an opportunity for consumers to buy a home before they have been able to save enough for a 20% down payment.