If you don't have enough to put down 20% on your mortgage, you will probably have to pay private mortgage insurance. So, what is it and how much does it cost?
What is PMI?
There are two types of mortgage insurance: private and government. If you have a government-backed loan, like an FHA loan, you pay mortgage insurance to the government. If your loan is not government-backed, you pay private mortgage insurance (PMI) to a corporate entity.
PMI pays benefits to your lender in case you default on your mortgage, but you pay for the coverage. Lenders typically require PMI of home buyers if they put down less than 20% of the home's value. Lenders see buyers with less money invested in a property as more likely to go into foreclosure, so they're trying to protect themselves against a default. It's the trade-off for being able to buy a home with as little as 3% or 5% as a down payment.
Expect your PMI cost to range from about 0.3% to 1.15% of your home loan. The most common way to pay premiums is in monthly installments, but you may also be able to pay your PMI in an up-front cost at closing or roll it into the cost of the loan. Ask your lender for its PMI options. Then do the math for both the long term and short term and compare it to your homeownership plans.
Getting rid of PMI
Once you have at least 20% equity in your home, you can request your lender to cancel your PMI. Once you have 22% equity, the lender is required to automatically cancel the coverage.
However, if you have an FHA loan, mortgage insurance premiums will last the lifetime of the loan. But they last that long only if you keep the loan through its entirety -- you can still refinance out of an FHA loan into another PMI-free mortgage when you have at least 20% equity.
If your loan isn't government-backed, PMI is not necessarily an absolute. You may be able to avoid PMI by doing the following:
- Paying a higher interest rate. This is known as lender-paid PMI. Keep in mind this can't be canceled and you'll need to refinance to get a lower rate.
- Using a piggyback loan to cover all or part of the down payment. Piggyback loans come with a higher interest rate, so use caution and do the math.
- Reappraising your house if you think property values and updates have boosted your equity (be aware you'll need to foot the appraisal bill).
Finally, some lenders may not require PMI for certain loan programs even if the buyer has less than a 20% down payment. These loans usually require sterling credit and other requirements. Consult your lender for more details.
A note on PMI tax deductions
PMI has been tax-deductible since the Mortgage Forgiveness Debt Relief Act of 2007. The act was most recently renewed at the end of 2014, but it is set to expire once again at the end of 2015. If Congress does not renew it, and no other bills are set in place, PMI will not be tax-deductible. Congress has a habit of waiting until the very last few weeks of the year to renew the act, so you won't know if your PMI is deductible until the end of the year.
Updated from an earlier version by Laura Sherman