Private Mortgage Insurance Explained for Homebuyers Putting Less Than 20 Percent Down
Making Homeownership Possible With Low Down Payments
Private Mortgage Insurance, or PMI, allows buyers to qualify for a conventional mortgage with as little as 3 percent down. For many first-time buyers, this makes homeownership possible years sooner than saving for a 20 percent down payment.
Mortgage insurance is one of the most misunderstood parts of the home loan process. Many homebuyers hear the term during the mortgage application, but are not always sure what it does or why it exists.
There are several types of mortgage insurance, and the terminology can get confusing. In this first article, we will focus on Private Mortgage Insurance (PMI), which applies to conventional loans. The next article in this series will cover government-backed mortgage insurance, including Mortgage Insurance Premium (MIP) for Federal Housing Administration (FHA) loans.
Before we explore the different types, it helps to start with a basic question:
What Is Mortgage Insurance
Mortgage insurance is an insurance policy that protects the lender if the borrower defaults on the loan.
It is generally required when the loan-to-value ratio exceeds 80 percent, meaning the borrower puts down less than 20 percent. Loans with smaller down payments carry more risk for lenders, and mortgage insurance offsets that risk.
While PMI exists to protect the lender, it also helps borrowers. Without it, many lenders would require a full 20 percent down payment. PMI allows buyers to purchase a home with significantly less money upfront, making homeownership possible for many people who would otherwise need years to save.
Private Mortgage Insurance vs Mortgage Insurance Premium
You will often hear two acronyms when discussing mortgage insurance:
PMI (Private Mortgage Insurance) is used for conventional loans.
MIP (Mortgage Insurance Premium) is used for FHA loans, which are government-backed.
Both serve a similar purpose, but they operate differently. In this article, we focus only on PMI for conventional mortgages. Government mortgage insurance, including FHA rules and costs, will be covered in the next article.
Types of Private Mortgage Insurance
One advantage of PMI is that borrowers can choose how the cost is paid. Each option has trade-offs.
Borrower-Paid Mortgage Insurance (BPMI)
The most common form. The borrower pays the insurance as part of the monthly mortgage payment, with no upfront cost at closing. This increases the monthly payment slightly.
Financed Mortgage Insurance (FPMI)
The cost is rolled into the loan as a lump sum. No upfront payment is required, but the loan balance increases. The borrower pays interest on the larger balance, and the premium is generally not refundable if the home is sold or refinanced.
Lender-Paid Mortgage Insurance (LPMI)
The lender pays the premium, but recovers the cost by increasing the mortgage interest rate. The monthly payment is higher because of the higher rate, and it stays in place for the life of the loan.
Single Premium Mortgage Insurance (SPMI)
The borrower pays the full premium upfront at closing. There is no monthly PMI payment, but it increases the cash needed at closing and is typically not refundable if the loan is refinanced or the property is sold.
Split Premium Mortgage Insurance
A hybrid approach. Part of the premium is paid upfront, and the rest is paid in smaller monthly installments. Monthly payments are lower than with BPMI. This can be helpful for borrowers near the maximum allowable debt-to-income ratio, since lowering monthly costs can improve qualification.
Benefits of Private Mortgage Insurance
PMI plays an important role in expanding access to homeownership. Without it, many lenders would require a full 20 percent down payment.
The biggest advantage is lower down payment options. Many conventional loans allow down payments as low as 3 percent, helping buyers enter the housing market sooner.
PMI also offers flexibility in payment options. Borrowers can choose monthly payments, upfront premiums, lender-paid structures, or split options depending on their financial situation.
Another benefit is that PMI does not last forever. Once the borrower builds enough equity, the mortgage insurance requirement can be removed.
Federal law requires lenders to automatically remove PMI once the loan balance reaches 78 percent of the original property value, provided the borrower has maintained a good payment history. Borrowers may also request removal earlier, once the loan reaches 80 percent of its original value, by contacting their loan servicer.
Removing PMI can be especially valuable if interest rates rise, allowing the borrower to reduce the monthly payment without refinancing.
Potential Downsides of Private Mortgage Insurance
PMI does add costs.
Monthly payments increase if the borrower chooses a monthly PMI option. Even when PMI is financed into the loan, payments are higher because the borrower pays interest on a larger loan balance.
Costs vary based on risk factors. Borrowers with lower credit scores, higher loan-to-value ratios, or higher debt-to-income ratios may face higher premiums.
PMI is underwritten separately by the mortgage insurance company. The lender approves the mortgage, but the insurer must also agree to insure the loan.
In some cases, a borrower may qualify for the mortgage but still be declined by the mortgage insurer. Lenders can request exceptions, but approval is not guaranteed. During my years as a mortgage underwriter, I occasionally saw this occur with borderline files.
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How Much Private Mortgage Insurance Costs
PMI costs vary based on borrower characteristics, property type, and mortgage structure:
Borrower characteristics: loan-to-value ratio, credit score, debt-to-income ratio
Property type: single-family home, condo, or multi-unit property
Mortgage structure: fixed-rate vs adjustable-rate mortgages
Rates generally range from 0.46 percent to 1.5 percent of the loan amount annually. The monthly cost is calculated using this formula:
Loan Amount × PMI Rate ÷ 12 = Monthly PMI Payment
Example: A borrower takes a $300,000 mortgage with a 0.65 percent PMI rate.
Annual cost: $300,000 × 0.0065 = $1,950
Monthly cost: $1,950 ÷ 12 = $162.50
In this case, the borrower would pay an extra $162.50 per month until enough equity is built to remove PMI.
If the borrower chooses a lump-sum option, the cost remains a percentage of the loan, but there is no additional monthly charge. This is a good choice for borrowers with extra cash at closing who want lower monthly payments.
Final Thoughts on Private Mortgage Insurance
Mortgage insurance is often misunderstood, but it plays an important role in today’s housing market. By allowing lower down payments, PMI helps many buyers purchase a home years sooner than they otherwise could.
The next article in this series will take a closer look at government-backed mortgage insurance, including FHA Mortgage Insurance Premiums, and how they differ from PMI on conventional loans.
