Many homebuyers overlook this common expense

If you’re in the process of shopping for a home—or plan to do so in the near future—make sure you understand if you’ll owe PMI, and if you do, how much it will add to the upfront and long-term costs of homeownership.

What is PMI?  

PMI is a type of insurance that lenders require when you make a down payment that’s less than 20% of the home’s price.  

As with other types of insurance policies, homeowners pay a premium for PMI coverage, either upfront at closing or on a monthly basis as part of their mortgage payments. In some cases, it’s a combination of both.  

Don’t be confused though: PMI doesn’t protect you, the buyer. Instead, it protects the lender, paying them back if you default on your loan. 

“Lenders charge PMI to lower their risk for buyers with smaller down payments,” says Curtis Wood, founder and CEO of mortgage app Bee. “Without a lot of skin in the game, these buyers are assumed to have a higher risk of default. The insurance policy protects the lender from loss.” 

PMI is specific to conventional loans only. FHA loans—or mortgages guaranteed by the Federal Housing Administration—charge mortgage insurance premiums (MIPs). These serve the same purpose but come with different costs and requirements.  

How much is PMI?  

The cost of PMI varies based on a number of factors, but generally speaking, Freddie Mac estimates it costs between $30 and $150 per month for every $100,000 borrowed.  

When calculating how much PMI you’ll owe, your lender will consider the following:

• Down payment: The smaller your down payment is, the more PMI coverage you will need. For example, if you make a 15% down payment, you’ll need enough PMI to cover 6% of your loan amount. If you make just a 4% down payment, you’ll need 35% coverage.  
• Credit score: Borrowers with lower credit scores are typically charged higher PMI costs because of the extra risk they present. Borrowers with higher credit scores, on the other hand, will face lower PMI fees. Your credit history—particularly your history of making payments on time—will also play a role. 
• Loan amount: Higher loan amounts also carry higher PMI costs. Smaller loans come with less risk for the lender, so they typically come with lower PMI premiums. 
• Loan term: Your loan term—or how long your repayment schedule is—also plays a role. You’ll need more PMI coverage the longer your term is. So, loans with 20-year terms or shorter require the least coverage.  
• Type of loan: Adjustable-rate loans are typically considered riskier and therefore come with higher PMI costs. Fixed-rate loans tend to be safer and have lower PMI premiums. 

When you apply for a mortgage loan, your lender should give you a loan estimate, which will detail the estimated costs you can expect—including any PMI charges. You should also receive a closing disclosure form at least three days before your closing appointment. This will show a final number for any PMI charges. 

How to avoid paying PMI  

Lenders charge PMI only if your down payment is less than 20%.  

If you don’t have enough cash on hand, you may be able to apply for a “piggyback” loan. This is a second loan you take out to use toward your down payment. 

“It means you have two mortgages—one for 80% and another for 20% of the property value. This way you’re not financing more than 80% of the home value with any one lender, thereby triggering PMI,” Wood says, giving an example.

If you’re willing to shop around, you may be able to find a lender that will pay your PMI premium on your behalf. Be careful, though. “This may come with a higher interest rate,” says Jess Kennedy, cofounder and chief operating officer at mortgage lender Beeline. 

How to get rid of PMI  

Fortunately, with conventional loans, PMI is only temporary. 

“You’re not stuck paying PMI forever,” says Kevin Quinn, senior vice president of retail lending at First Internet Bank. “Once equity has been built in the home, there are multiple ways for the borrower to shed PMI and possibly lower their monthly payments.” 

Once you reach 80% equity in the home—meaning your mortgage balance is no more than 80% of your home’s value—you can request that your lender cancel your mortgage insurance policy. When you hit 78% equity, PMI should drop off automatically. 

One way to work toward that 80% is by improving your home’s value by making upgrades to it. Then you’ll need to submit a PMI cancellation request with your lender in writing. You’ll also need to be current on your payments, and the lender may request an appraisal to confirm the value of your property.

Another way to get rid of PMI is to make efforts to pay down your mortgage’s principal balance faster. 

“Pay extra each month, or make a full payment on the first, then biweekly payments on the 15th and first thereafter,” Wood says. “This saves you one month’s payment for every year you do it. In 12 years, you’ll be a full year ahead.”   

Is PMI tax-deductible?  

Despite its costs, PMI isn’t all bad. For one, it can allow you to buy a home when you don’t have a large down payment on hand. 

“You may be able to get into a home you couldn’t otherwise buy if you needed to bring 20% down,” Kennedy says. “So it does make property ownership more accessible.”    

PMI is also tax-deductible—but only if you itemize your deductions (instead of taking the standard deduction, which most people take each year). According to the IRS, PMI costs can be deducted from your adjusted gross income for the year in which they were allocated. 

To be eligible, you must make $100,000 or less if you’re single ($50,000 if you’re married filing separately) in order to take the full deduction. If you make between $100,001 and $109,000 as a single filer ($50,001 to $54,000 married and filing separately), the deduction is reduced by 10% for every $1,000 over the $100,000 limit. A household income beyond these thresholds disqualifies you from the deduction altogether.

Keep in mind that this deduction has been available in the past for certain tax years, up to 2021. It’s still unclear whether this will be available for 2022 and beyond.

The takeaway 

PMI can add significant costs to your home purchase—both upfront and over the long term. If you know you’ll need PMI when buying a home, be sure to factor the price increase into your budget early, before you begin searching for a property. 

And if you want to avoid PMI costs, think ahead. Consider making a larger down payment, or shop around for a loan with lender-paid PMI. In some cases, a piggyback loan may also be an option. Talk to a mortgage professional or financial adviser if you’re not sure which strategy is best for your goals.

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