Understanding PMI: A guide to private mortgage insurance

After a long day of work, it’s nice to come home to a place you can call your own. Unfortunately, homeownership comes with a few costs. There’s your down payment, homeowner’s insurance, property tax, monthly payments with potentially high interest rates plus more. All those costs of homeownership can make it difficult to get the mortgage and the house that gives you peace of mind.

Private mortgage insurance (PMI) is also an often-overlooked cost that homeowners may need to pay when buying their new home. It may be required if you are buying a home with a conventional mortgage or refinancing your current loan. Understanding PMI, however, can help you to avoid paying it or pay less of it, saving you money in the long term. Here’s what you need to know:

What exactly is PMI?

Private mortgage insurance (PMI) is an additional cost that typically applies when you have a conventional mortgage and can't make a 20% down payment. It might also be required if you refinance your home and have less than 20% equity. PMI protects the lender in case you default on your mortgage payments. That means you could still be at risk if you’re unable to make a mortgage payment. Luckily, there are ways to avoid PMI, potentially making your mortgage more affordable while helping you put more money toward equity and interest!

How much does PMI cost?

PMI usually ranges from 0.5% to 2% of your conventional mortgage balance annually, but it can get as high as 6%.¹ The exact cost depends on various factors including your down payment size, loan amount, loan term and credit score. Of course, one or two percentage points may not sound like much, but think about it this way: A 1% PMI rate on a $400,000 mortgage would mean an additional $4,000 per year, or around $333 per month. Also, while your mortgage principal can help you build equity and your loan interest is tax-deductible, PMI mainly offers protection for the lender. That can make it a good idea to look for programs with lower or no PMI.

How do I pay for PMI?

PMI is most commonly paid through a monthly premium added to your mortgage payment. Some lenders may offer alternatives such as paying a single upfront premium at closing or a combination of an upfront payment and monthly premiums. Review your loan documents to understand the exact costs and payment schedule for PMI.

But what if I don’t want to pay PMI?

The simplest way to avoid PMI is to make at least a 20% down payment when purchasing a home. Understandably, that can be difficult, especially when the values of homes skyrocket. If putting 20% down is not feasible, consider looking for loan options that don't require PMI. While these might come with higher interest rates, they can be helpful if you don’t want to foot the bill for the lender’s protection. Whether such a loan is right for you will depend on how long you plan to stay in your home and other factors like the tax-deductibility of mortgage interest. It’s always a good idea to consult a tax advisor to evaluate your options.

There are also government-backed loans like those from the Federal Housing Administration (FHA) that allow you to avoid PMI with lower down payments and reduced interest rates. These loans are made possible because the government guarantees them, lowering the risk for lenders. Eligibility and terms will depend on factors like your credit score, the lender and current market conditions.

Can PMI be removed?

The good news is that PMI isn't permanent. It can typically be removed by submitting a cancellation request to your lender once you have 20% equity in your home. However, you can take steps to reach this level sooner:

• Pay down your mortgage faster: Making extra payments toward your mortgage principal can reduce the balance faster, helping you build equity more quickly.
• Home reappraisal: If your home's value has increased, a new appraisal could show that your mortgage balance is 80% or less of the current home value, possibly allowing you to request PMI cancellation. Keep in mind that an appraisal can cost $300 to $600, so try to be sure your home's value has indeed risen before proceeding.
• Refinancing: If you refinance and the new mortgage is less than 80% of your home's appraised value, you might be able to eliminate PMI.

What’s the real cost of PMI?

The real cost of PMI is two-fold. There is the obvious financial aspect of PMI, as it adds to your monthly expenses when buying a home. At the same time, there’s a mental component. Saving 20% is difficult, especially during periods of high inflation and rising housing costs.

The wait, however, can be worth it, possibly buying you some time to save. For example, renting can give you a place to call home without holding you responsible for insurance, property tax or maintenance. It may also give you time to wait out seller-friendly markets, or you may find the right person to help you save and split housing costs with. Opting for a less expensive home could also save you money by lowering your mortgage payment and eliminating PMI.

Are there assistance options for PMI?

Depending on how much you’ve saved for a down payment, PMI might be necessary to help you purchase a home. However, there are programs that can help minimize or avoid PMI costs. For example, the Community Heroes First-Time Homebuyer Program from Desert Financial aims to make it easier for local heroes to get into houses.

The Community Heroes First-Time Homebuyer Program comes with perks like no down payment, competitive rates, closing cost credit of up to $7,500 when you participate in the Home Plus Program² and local loan servicing.³ It then tacks on the added benefit of no PMI, eliminating yet another obstacle to owning a home.

Make your house a home

To learn more about these programs, talk to your mortgage loan officer today. They can help you understand what you qualify for and the different benefits of each program. So, relax, put your feet up and make yourself at home, because we’re here to help you every step of the way!