Private mortgage insurance (PMI) is a type of insurance policy that protects lenders from the risk of default and foreclosure, allowing buyers who are unable to make a significant down payment (or those who choose to not to) to obtain mortgage financing at affordable rates. If you purchase a home and put down less than 20%, your lender will minimize its risk by requiring you to buy insurance from a PMI company prior to signing off on the loan.
Private mortgage insurance benefits the lender (the sole beneficiary of PMI), but it can add up to a sizable chunk of your monthly house payments. Typically, you send one payment to your lender each month to cover both the mortgage (principal plus interest) and the insurance premium. PMI rates vary, but may range between 0.3% and 1.2% of the loan amount on an annual basis. Your rate will depend on several factors, including:
- Size of your down payment. PMI will cost less if you have a larger down payment (and vice versa).
- Your credit score. The higher your credit score, the lower your PMI premium.
- Potential for property appreciation. If you live in a market with declining property values, your PMI premium might be higher.
- Loan type. The riskier the loan is to the lender, the higher your PMI.
- Borrower occupancy. If the financed property will be owner-occupied (you will be living there), your PMI premium will be lower than if it is a rental or investment property.
Assume you have a 30-year 4.5% fixed-rate mortgage for $200,000. Your monthly mortgage payment (principal plus interest) would be $1,013.
If PMI costs 0.5%, you would pay an additional $1,000 per year, or $83.33 each month, bringing your monthly house payment up to $1,096.70. You may also be able to pay your PMI upfront in a single lump sum, eliminating the need for a monthly payment. This can be paid in full at closing or financed into the mortgage. In many cases, this is the more affordable option as long as you plan on staying in the home for at least three years. For the same $200,000 loan, you might pay about 1.4% upfront, or $2,800. Ask your lender for details on your PMI options before making any decisions
PMI protects the lenders for loan amounts above about 80% of the property's value. For example, if a person purchases a home with only 10% down, the insurance protects the other 10% so that the lender is at risk for only 80% of the loan-to-value. For the best estimate on PMI costs, my recommendation is to ask the mortgage provider. In general, it seems to be priced around 0.5% to 1.5% per year for the total loan amount, subject to a number of factors. Since the range is so wide, one must get a firm quote based on the exact situation to have some certainty as to the actual cost.