Private mortgage insurance, better known as PMI, has had a bit of a moment lately.
While the COVID-19 pandemic chilled the housing market somewhat, low interest rates meant to stimulate the economy also presented an opportunity for those in a position to refinance their mortgage. One of the benefits of refinancing is the chance to drop any PMI payments built into your original loan, or to get a loan that will drop the payments down the road.
Early indicators of a potential housing market rebound started to show by late April. So whether you’re looking to refinance or looking to purchase a new home, it’s important to know about how PMI will affect your budget.
What Is PMI?
Private mortgage insurance is a type of insurance policy that protects your lender in the event that you stop making payments on your home. With PMI in place, mortgage lenders will accept more risk, financing more than 80% of your home if you can’t afford a minimum 20% down payment. PMI insurance payments are either made monthly or in a lump sum, depending on the arrangement you have with your lender and insurance provider.
Do You Need PMI?
As a rule of thumb, anyone who puts less than 20% down on their home will be required by their mortgage lender to take out a mortgage insurance policy. There are a few exceptions. For example, veterans who participate in the VA home loan program can put as little as 0% down without needing PMI. Zillow notes that credit unions will occasionally waive PMI for applicants on a case-by-case basis.
Some financial institutions will also ask buyers with poor credit or inconsistent income to get PMI, even if they make a significant down payment. It’s all about risk; if your lender doesn’t see sufficient proof that you’ll make your mortgage payments on time, they’re more likely to demand PMI.
Chasity Graff, a mortgage broker and owner of LA Lending, LLC, says PMI should be offered to homeowners even if they don’t absolutely need it, because it can provide flexibility. “It should be considered more of a financing tool,” says Graff. “To determine whose finances would be served best by a loan with mortgage insurance versus utilizing another mortgage program, a loan specialist needs to really dig in and look at it from all angles.”
With all the options on the table, Graff believes, the borrower and the mortgage broker can work together to find the perfect balance of down payment, rates, programs, and insurance.
But it’s best to dodge PMI altogether if you can, says personal finance expert Chris Hogan, a best-selling author and veteran of Dave Ramsey’s Ramsey Solutions team. “We’re talking two to three to four hundred dollars extra a month for PMI,” Hogan says. “That is a big deal and adds up quickly.”
How You Can Avoid Paying PMI
The most straightforward way to avoid paying PMI is by putting more than 20% down on your home. If you don’t have the cash on hand, there are a few ways to do this. One is by “piggybacking,” a term that refers to taking out a second loan to cover all or part of your down payment. The main disadvantage is that this second loan will likely have a higher interest rate than your mortgage. You could end up paying more in interest fees than you would by simply taking out a mortgage insurance policy.
Some home buyers find success financing their down payments through grants and other assistance programs. The Federal Housing Administration offers a list of down payment grant programs by state that you may be eligible for. One common type of program involves incentives for first-time home buyers, aimed at younger generations who are too burdened by student debt to afford a down payment. However, not everyone will qualify for these programs.
There’s also the option of liquidating other assets to increase the amount of cash you have on hand for a down payment. For example, if you’ve put money into stocks or other investments, you could consider selling some of them to increase your down payment.
Finally, you can simply wait until you’ve saved up enough money to make a bigger down payment. Most experts say low interest rates won’t go away any time soon.
If you’ve decided that PMI is right for you, work with your mortgage broker to fit it into your overall budget. “I wish more buyers knew how to put PMI into perspective,” says Niko Apostal, founder and principal broker at the Apostal Group at Keller Williams Chicago. “Most try to avoid it at all costs since it seems like an additional cost, but it can be beneficial if it means that they can qualify for a better loan or a better mortgage rate. It may be worth the cost over time.”
The Cost of PMI
How much you pay for mortgage insurance will depend on your down payment, loan type, and creditworthiness. On average, you can expect to pay between $30 to $70 per month for every $100,000 on the loan, according to FreddieMac.
For example, if you take out a mortgage for $250,000, you’ll pay somewhere between $1,250 and $2,500 per year in mortgage insurance. This translates to somewhere around $100 and $200 per month.
One important note: Different lenders are likely to offer different PMI insurance rates. This is something you can and should ask about as you’re shopping around for a mortgage.
Is PMI Tax Deductible?
Your PMI payments are tax deductible, but the deduction doesn’t apply to everyone. You qualify for the PMI deduction if:
- You are taking an itemized deduction. About 90% of households take the standard deduction, which will be $12,400 for the 2020 tax year. You’ll have to calculate how much you paid in PMI in 2020 to see if it exceeds the standard deduction and would be worth you time.
- Your adjusted gross income (AGI) is under $109,000. Beyond that limit, you cannot claim the PMI deduction. And between $100,000 and $109,000, the amount of PMI deductions you can claim is reduced by 10% for each incremental $1,000 you make. This applies to both single taxpayers and married couples filing jointly.
We recommend consulting with a tax professional if you plan on itemizing your deductions, as the process can be confusing and complicated.
When Can You Cancel PMI?
If you are required to pay private mortgage insurance, know that it doesn’t have to be forever. The ability to drop PMI from your mortgage is actually covered by the federal Homeowners Protection Act (HPA). For specific questions about your PMI, we’d recommend talking with your lender. But know that the HPA provides for two key ways to drop PMI payments:
- When your mortgage balance reaches 78% of the original price you paid for the home, the lender must automatically cancel PMI if you are in good standing and haven’t missed any payments.
- Once you have reached 20% equity in your home, you can request PMI cancellation and the lender is required to cancel, assuming you are current on the mortgage and have a good payment history. You may have to make the request in writing and meet other lender requirements.
If you do choose to put down less than 20%, Hogan recommends building equity in the home as quickly as possible — such as by making additional payments toward your principal — to drop your PMI payment sooner than later. As long as you pay your mortgage on time each month, you’ll continue to build equity in your home. Once you reach 20% equity, you can ask your lender about canceling your PMI policy.
But making payments isn’t the only way to kick your mortgage insurance payment to the curb. Another factor that can help accelerate the process is home appreciation. If the value of your home goes up, it may be enough to push your loan-to-value ratio below the 80% threshold.
“In most cases, PMI can be eliminated altogether if the value of the property increases to meet the risk threshold for the lender,” says Apostal. “I personally wouldn’t hesitate to go ahead with a loan that includes PMI if the property is in a rapidly appreciating area and the other loan terms are great.”
The Bottom Line
While it’s tempting to demonize PMI, most industry experts recognize it as a financial tool that opens new doors to homeownership. “Mortgage insurance is not a four-letter word,” says Graff. “In reality, it allows for many more home buyers to access conventional financing options years sooner than they normally would.”
That said, if you’ve been asked by your lender to purchase mortgage insurance, it’s always a good idea to explore alternative options. Work with a financial adviser to look at the big picture, choosing the best option for your long-term financial health — whether or not that includes paying for mortgage insurance.