The True Cost of Private Mortgage Insurance

Here we are. You’ve saved up, you’ve done your research, and you’re finally ready to buy a house. Congratulations! It’s a big milestone that not everyone takes the time to always appreciate. But, before you start shopping for your dream home, you need to know about private mortgage insurance (PMI). If you’re putting less than 20% down on your home, chances are you’ll be required to pay PMI. If this is your first time reading about private mortgage insurance you better start sweating, this is going to be tough. Kidding, for the most part. In this article we are going to explore what PMI is, how it works, and how much it will cost you. So, let’s dive in! Feet first though, please. Maybe just your toes, actually.

What is Private Mortgage Insurance?

Private mortgage insurance is type of insurance that protects lenders in the event that a borrower defaults on their home loan. If a borrower were to default, that means the borrower is not making their payments and have already missed four consecutive payments. If you are putting less than 20% down on your home and are required to pay PMI, it will typically add 0.5–2% of your total loan amount to your annual mortgage payment. For example, if you’re taking out a $200,000 loan with 10% down ($20,000), your annual PMI payments could range from $1,000 to $4,000. We will break down the costs of this a little bit further down. Don’t worry, PMI does not last forever, so these additional expenses are short-term.

How Does Private Mortgage Insurance Work?

Your lender requires you to pay PMI if you’re unable to make a 20% down payment on your home (do not feel bad if you cannot or decide not to, a lot of people don’t). Once you’ve paid down 20% of the loan you can request that the lender cancel your PMI coverage. In most cases, the lender will automatically terminate coverage once you’ve paid down to 78% of the original loan value. But, do not keep paying PMI for longer than you have to, so either try to pay down your house as quickly as possible to reach that 20% mark or at a minimum request it to be removed when you do reach 20% after making the standard monthly payments.

While having to pay PMI can be frustrating, remember that it is there to protect both you and your lender in case of default. And once you reach 20% equity in your home, you can request to cancel the coverage. Treat that as motivation to pay down your house a bit faster until you have 20% paid off! One rule of thumb to pay down your mortgage sooner is by either making one extra payment per year or paying an additional 10% per month towards your principal. Either route will help you pay off your loan 6–8 years sooner! Not bad too shabby. Just made your 30 year mortgage go down to a 23 year loan. But, back to PMI!

How Much Will Private Mortgage Insurance Cost Me?

The amount you’ll pay for PMI depends on several factors: credit score, loan type, and down payment amount. In general, borrowers with lower credit scores will pay higher premiums than those with higher credit scores — since they typically pose a greater risk of defaulting on their loans. The type of loan also affects premium rates. For example, FHA loans tend to have higher premiums than conventional loans because they’re backed by the government. Finally, the size of your down payment also plays a role. So, expect borrowers who make smaller down payments to pay higher premiums than those who make larger ones.

For example, let’s say you’re taking out a $200,000 loan with 10% down ($20,000). Your annual PMI payments would range from $1,000 to $4,000 based on the factors listed above.

$1,000 is 0.5% of the total loan amount ($200k), while $2,000 is 1%. To put that into perspective — if we assume a 4% interest rate and 30-year term — your monthly mortgage payments would be around $950/month without PMI or around $1125/month with PMI (assuming a 1% premium). That comes out to an extra $175/month or $2100/year. Monthly and annual payment amounts are estimates only and since other costs like insurance an taxes fluctuate depending on where you live. Actual payments may be higher.

As you can see from the example above though, adding PMI onto your mortgage payments can significantly increase the amount you owe each month — so it’s important to factor that into your budget when shopping for a home.

With all that being said about private mortgage insurance (PMI), does it make sense for everyone to put 20% down on their homes? Not necessarily. There are so many variables that impact the ability or desire for someone to put that much towards their down payment. Even if you have to or decide to put less than 20% down right away, just know that as long as the value of your home increases at historic averages, it should far exceed the annual amount going towards your PMI. Just know that most people who get a mortgage end up paying PMI, so do not think you are doing anything wrong or did something incorrectly to have to pay for this. Even with the costs of PMI, the benefits of owning a home far outweigh those costs.

This is not financial advice. For educational purposes only. Before making any financial decisions, consult with a professional.