The Cost of PMI on Your Mortgage

The days of needing to have 20% to purchase a home are no longer (yay!) However, it’s important to know that if you do not have the whole 20%, you will need to have PMI either built into your loan or purchased up front (boo!). As you think about buying, it’s important to discuss your options with your lender and consider all costs involved with obtaining a loan.

What is Private Mortgage Insurance?

Private mortgage insurance (PMI) is an insurance policy that lenders require to cover the risk associated with a mortgage loan with little to no equity. This insurance ensures that if the borrower defaults on the loan, the lender can recoup the costs associated with foreclosure. Borrowers are required to pay PMI until the mortgage loan is less than 80% of the home’s value. More on removing PMI from a mortgage below.

How is PMI Calculated?

PMI is calculated by paying a percentage of the loan balance each year. The percentage varies by insurer, loan type and borrower’s credit qualifications. Borrowers with lower credit scores will typically pay a higher mortgage insurance premium each year. The chart below illustrates how this insurance is calculated by an example institution. It is based on a mortgage amount of $360,000.

Private mortgage insurance is added to your mortgage payment each month and is put into an escrow account. The mortgage lender will pay the bill each year. Rates may adjust each year, allowing your mortgage payment to flex. In order to remove PMI from your loan, most lenders require that a refinance is done and a full appraisal is completed to show that the value of the property does give the homeowner 20% equity.

Is It Worth it to Pay Private Mortgage Insurance?

The premiums on PMI may seem very expensive. Since homeowners pay the most interest at the beginning of a loan it can take several years to pay down the loan to less than 80% loan to value.

However, for the average American homebuyer, saving up a 20% down payment would take many years and cost them time and money in both equity potential and money spent in rent. Many home buyers decide to use loan options with smaller down payments required and pay PMI so they can start their ascent up the property ladder.