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What is PMI & How Much Does it Cost?

If you’re purchasing a home for the first time, you may not be aware of other costs associated with buying a home in addition to monthly mortgage payments. One of those costs is private mortgage insurance, commonly referred to as PMI. For many homebuyers who have not been able to save for a big down payment, PMI can help them to still purchase a home instead of having to pay rent. Let’s look at homebuyers’ commonly asked questions about private mortgage insurance, what its purpose is, and when and how you can stop paying it.

FAQs about PMI

Q: What is private mortgage insurance?
A: Private mortgage insurance, or PMI, is a type of insurance you pay if you have a conventional loan and make a down payment that’s less than 20% of the home’s loan value. The 20% down payment guideline is set by the government, so mortgage insurance companies have to underwrite and insure the lender for the difference.

Let’s break this down a bit:
  • A conventional loan is any type of homebuyer’s loan that’s not offered or secured by a government entity (such as VA loans or FHA loans made by The Department of Housing and Urban Development — more on this later). Conventional loans are available through private lenders, such as banks, credit unions and mortgage companies. In other words: These are the types of loans your community banker would provide.
  • A down payment is a percentage of your home’s purchase price that you pay upfront when you close on your home loan. Lenders often look at the down payment amount as your investment in the home. This shows your bank initial commitment to the loan, so it’s not taking all the risk if you don’t pay your mortgage.
  • A home’s value is determined on a number of factors, such as comparable property features, an appraisal and valuation tools. This is what your home is worth, or In other words, how much someone is willing to pay for it.
Now let’s put this into more relatable terms.

Q: How do you know if you’ll be paying PMI?
A: Say you want to buy a $200,000 home using a conventional loan from your hometown bank. Most conventional lenders require homebuyers to put down at least 3.5% when they buy a house (if you’re curious, in 2021, the average homebuyer put down a 12% down payment). But a federal guideline of 20% down lowers the bank’s lending risk, so the bank has incentive to offer you more competitive interest rates.

So for a $200,000 home, to reach 20% of the home’s value you’d need to put down $40,000 of your own money. And admittedly, that’s a lot of money for many homebuyers to pay up front.

The lenders at your hometown bank already know this. They still benefit by loaning you the money, but they want to reduce their risk in case you default on the mortgage — after all, it’s their money you’re using to purchase a home, which means your investment is their investment too.

Q: How much is PMI?
A: Here’s an example of how PMI works: For your $200,000 house, you put down $20,000, which is 10%. You’ll need to pay PMI for the additional 10%, or $20,000, to hit that 20% down payment threshold set by the government. In 2021, mortgage insurance rates were typically between 0.2% and 2.25% and depend on things like your credit score, down payment amount, type of mortgage, and size of your home loan.

Q: When Do You Stop Paying PMI
So let’s say you got a 30-year loan, your interest rate is 3%, and your PMI rate is 1.75%. Your PMI premium payment will last the first 5 years of your mortgage and will cost you $263 every month, on top of your normal mortgage payment. That equates to a total PMI premium of $15,772 after the 5 years.

Note, you don’t get PMI money back, because it pays for risk insurance to cover the bank’s loss in case of default on the loan.

If you’d like to test out different loan and down payment amounts, interest rates, loan terms, and PMI percentage rates, try this nifty PMI calculator. Plug in your numbers and it’ll show you how long it may take you to pay off your PMI premium payment.

Q: How can I avoid paying PMI?
Aside from putting 20% cash down, it’s possible to avoid paying PMI in other ways, though none of these ways may save you money.
  • If you qualify, get a Federal Housing Authority (FHA) mortgage loan. These loans require what’s called an Up Front Mortgage Insurance Premium and a mortgage insurance premium (MIP) to be paid instead. Depending on the terms and conditions of your home loan, most FHA loans require MIP for either 11 years or the lifetime of the mortgage.
  • If you’re a current service member or a veteran, get a Veteran Affairs (VA) loan. These are backed by the Department of Veterans Affairs and are for current and veteran service members and eligible spouses. They don't require mortgage insurance, although there is a one-time funding fee.
  • Get lender-paid mortgage insurance (LMPI). This is where the cost for PMI is included in the mortgage interest rate for the life of the loan. But you may end up paying more in interest over the life of the loan.
  • Take out a piggyback loan. Say you can only put 5% down for your mortgage. By taking out a second “piggyback” mortgage for 15% of the loan balance, and combining that with your own 5% down, you reach your 20% down payment.
Interested in buying a home? Talk with the experts at First National Bank and Trust
We can help you become a homeowner, whether it’s your very first home, a vacation home or an investment property. We offer a wide range of home loan and home equity loan programs, and our experts can help you decide which might be right for your needs.

Get started on your path to homeownership today — simply stop by one of our 16 locations, or contact us.