The Lowdown On Private Mortgage Insurance

Note: I was informed by several readers that PMI traditionally stands for private mortgage insurance, so I updated the article to reflect that.

Many first time homebuyers are daunted with the prospect of saving up six figures to afford that 20% down payment, so they often take out home mortgages for less than a 20% down payment. This usually means that the dreaded private mortgage insurance (PMI) is part of the deal.

What is PMI Insurance?

PMI refers to an insurance policy on your mortgage. Lenders often require that borrowers who don’t have enough cash for a 20% down payment take out a PMI policy. This policy generally costs between 0.5% and 1% of your mortgage annually.

How do you get rid of PMI?

Generally, your PMI goes away after filing paperwork with your lender. This usually requires that your house be reassessed and it be shown that you currently owe less than 80% of the value of your home.

For many people, reaching that 80% threshold and getting rid of that PMI is a major goal. Their philosophy is that they’re just throwing away that 0.5% or 1% a year on PMI that they can reclaim, so they hurry up to pay it off. While this makes a lot of sense at first, paying off your mortgage early to get rid of PMI might not always be the smartest choice.

Here’s an example that a reader sent me a while back. He had a mortgage at 5.875% fixed and a PMI at 0.6%. However, he also had an auto loan at 7% and a few outstanding credit card bills way over 10%. He told me he was paying the mortgage early to get rid of that PMI. I told him it was a bad move, and here’s why.

The best way to determine the true impact of PMI on your finances is to add together the mortgage interest rate and the PMI rate and use that as the basis to determine which loans you should pay off first. So, in the example above, the effective mortgage rate would be 6.475%. Thus, the smartest move for that person to make would be to pay off the credit cards and pay off the auto loan before worrying about prepayments on the home loan at all.

What about when the PMI disappears? Once the PMI is gone, it’s a good time to re-evaluate which debt should go first. Let’s say, for example, the individual above has a car loan at 6%. That person should pay off the home loan down to 80% before paying ahead on that car loan. Then, when the PMI is gone and the interest rate on the mortgage goes down to 5.875%, then the person should focus on getting the car paid off.

In short, don’t let the fact that you can make the PMI disappear cloud you from making sound debt repayment choices. Treat it as extra interest on the home loan and use that as the basis for determining whether mortgage prepayment takes precedence over paying off a car loan – just compare those rates.

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  1. Chris says:

    I’m pretty sure it stands for private mortgage insurance. http://en.wikipedia.org/wiki/Lenders_mortgage_insurance

  2. Chris says:

    I was also hoping when I read the title that this article might discuss the pros and cons of taking out alternative mortgages or second mortgages to finance the 20% in leiu of doing pmi as this is something I’ve been having to consider recently in my search for a house.

  3. Jim Lippard says:

    I thought it was “private mortgage insurance.” It’s insurance for the lender, not for you, and it’s a good thing to avoid by putting 20% down. A lot of people have avoided PMI over the last few years by paying 20% via a second mortgage, but this has some potential negative implications if you end up defaulting.

  4. Ben says:

    Personally, I had the option of PMI for my loan and I turned it down. The time it takes to own 20% of your home is longer than you think.

    PMI is also money that goes nowhere, it’s just like a fee for not having enough money. My bank offered me a 80/10/10 loan.

    80% house, 10% down, and a separate 10% loan which I have 10 years to pay, and no penalties if I pay it off no earlier than 3 years. This way, every dollar of my house payments are going towards the house, and not PMI waste.

    This also allowed me to get a house for the same interest rate (actually a little lower) and STILL not have to come up with 10% down. I had close to 17% down, so I did the 80/10/10 loan and had a little more money to use with the upstart appliances. I also have shifted the 10% loan to be a later payment in the month, which gives me more flexibility in my payment scheme than the higher PMI included mortage payment on teh 1st.

    Just my .02

  5. Ben says:

    Whoops I meant:

    “STILL not have to come up with 20% down.”

  6. Jim Lippard says:

    Oh, now I see Chris asking what the pros and cons are of using a second mortgage/HELOC for 20% to avoid PMI. The big pro is that you avoid PMI. The cons are that you have another loan to pay off (usually with higher fees and interest rate), your increased leverage means that a decline in value will more quickly put you in the red, people who do this are more likely to default. If you default, lose the home, and owe more than it’s worth, the presence of a HELOC may (depending on state) mean that you will continue to carry that debt, the HELOC lender can attach it to other property you own, etc.

    Also note that if you default while owing more than its worth, any forgiven deficiency counts as taxable income to the IRS.

    In my opinion, if you can’t afford to put 20% down, you probably can’t afford the house. I also think you shouldn’t buy a house that costs more than 2.5 times your annual salary.

  7. Lisa says:

    If your down payment on a home is less than 20 percent of the appraised value or sale price, you must obtain private mortgage insurance, known as PMI, with your lender. It’s PRIVATE MORTG INSUR, not “pre-mortgage insurance” — just FYI :-)

  8. Mitch says:

    Private mortgage insurance?

  9. kim says:

    He Trent, I think your a great writer, but sometimes I think you over step by giving advice in areas in which you have little knowledge. It’s Private Mortgage Insurance not pre-mortgage insurance. I’m not saying that the advice you gave in this post is necessarily bad, but you really erode your credibility when you don’t even know the name of the thing your on which your advising.

  10. James Morgan says:

    I don’t know many people who have to save up even close 6 figures for a 20% down payment. A 6 figure down payment at 20% is for a $500k+ house. Double what the average American spends on a house.

  11. Luke says:

    “daunted with the prospect of saving up six figures to afford that 20% down payment”

    Did you mean five figures or are you really talking about people buying at least a $500,000 house as their first house?

  12. Jason says:

    Hi, Trent,

    To expand (hopefully in better grammar and syntax than the last poster): PMI stands for private mortgage insurance. It stands in contrast to the public mortgage insurance offered by the VA or FHA, which allow borrowers who meet specific criteria to get a loan with less than 20% down without obtaining insurance against their default. The rest of the post had some good advice. Thanks.

  13. SD says:

    I have a small PMI on my mortgage, I weighed the options and figured I could deal with it. It is tax deductible for ths year. Where I live the tax assessor is very persuaded on the assessment of house. Is it possible to assess the house at a higher value and get rid of the PMI sooner, I understand the taxes well go up. Just wondering.

  14. Justin says:

    Some lenders waive PMI for low-income first time home buyers. Bank of America set me up at a very reasonable fixed interest rate, a Mortgage Credit Certificate, no PMI, and a grant from the city to pay for my down payment.

    A knowledgeable loan officer who can set up all those kinds of deals for a qualifying first time buyer is worth a whole lot more than a lender who just has the best interest rates.

  15. !wanda says:

    A lot of the blog’s readers, at least the commenters, seem to live in areas where housing prices are very high. (Example: I have a friend who is trying to buy housing in San Francisco who claims that there is nothing under 600k, and properties in the 600-700k range are snapped up quickly for far more than the list price.) Perhaps people who want a house but who live in areas where housing prices are disproportionately high are more willing to read a personal finance blog.

  16. Second that says:

    Thank you !wanda–we’re definitely in the situation where it would take 100K to get to 20% for just about anything in our area. We actually have that much saved. The problem is that the only stable income is my husband’s base income. He does get bonuses and as a grad student I do pick up jobs here and there, but a mortgage is the same month after month. So we can put down 20%, but can we pay mortgage on $400K? That’s a totally different story. Hoping to move to some place cheaper after I’m done with school.

  17. Stephen says:

    Another keypoint about PMI ….

    As your accumulated principal payoff starts to approach the 20% mark, it will most likely make sense to pay the additional amount of money needed to get you over the hump, so you can stop paying PMI.

    For an example with simple numbers, if your PMI is $50 a month and you are only $1,000 away from paying off enough of the principal to stop the PMI payments, you are effectively paying a 60% interest rate for that last $1,000.

    Its definitely something to watch out for as you atart to approach the 20% mark.

  18. Engineer says:

    With a 5.875% fixed mortgage rate and a PMI at 0.6% the effective mortgage rate could actually be less than the 6.475% for many people. Mortgage interest is deductible from your income taxes, and in 2007 PMI is as well.

    Even if you don’t have other debts to consider, there are other priorities to getting rid of PMI. Such as making sure that you’re participating in tax-advantaged retirement savings.

  19. Brip Blap says:

    @Luke,@Wanda, yes, first-time homebuyers in certain areas are spending $100,000+ on down payments. I live in the NYC area and I fully expected to pay – and did – over $100,000 on my first home’s down payment. A $500,000 “starter home” in the NYC area is not at all out of the question. I would not have bought the house if I couldn’t afford that 20% down payment. We did take out a short-term HELOC to cover some of the down payment, but it was mainly for me to spread some large stock liquidations out enough to get long-term tax treatment. I ran the numbers, it worked better – interest rates were low at the time.

    @Justin – if you don’t mind sharing, where exactly do you live that your city gave you a grant towards a downpayment? Was it some sort of neighborhood reclamation project or something? I’ve never heard of such a thing before, I’d be interested to hear more.

  20. js says:

    In Los Angeles a 20% down payment would be 6 figures for sure (most homes are at least 500k something, and yes even little 2 bedroom starter homes are 500k+!). Heck I’ve seen condos for 500k and up (but those are probably overpriced even for here). And of course if you are willing to drive 2 hours to work you might get a bit cheaper ….

    Now, how many first time home buyers, in Los Angeles, have 100k saved up (not counting retirement money)? Not many I’d figure!

    As for not paying more than 2.5 times your income on your house, well that really doesn’t apply to this market (not many 200k incomes about).

    I think we may have a bubble here :). Ah well, not being stupendously rich, I rent. Yea, I’m one of those “financially irresponsible”, renter types with no financial sense ;).

  21. James Morgan says:

    OK, take NYC and California out of the equation and virtually nobody in America needs 6 figures for a 20% down payment. You are the exception, not the rule.

    The average home in America sells for under $250k. How much did Trent pay for his house? I don’t remember if he mentioned specifically, but I think he was looking at houses that were under $200k. And people in similar situations as him seem to be his target market, right?

    Therefore, a 6 figure down payment is ridiculous to even mention unless it’s specifically referring to the minority of home buyers who live in high priced areas.

  22. Tordr says:

    In Scandinavian countries they do not have PMI, but the banks make you pay different rates based on how much money you put down. The bank quotes you rates for 100%, 80% and 60% mortgages. Currently the premium for 100% vs. 80% is about 1% interest and between 80% and 60% the difference is about 0,5%.

    There is no automatic rate reduction, so you have to go to the bank to ask for a rate reduction once you own 20% of your house. I think having a PMI that goes away when you have paid 20% of your house is a cleaner way of doing things.

  23. plonkee says:

    @Tordr
    Its the same situation in the UK, except that for the rates are for 100%, 95%, 90% and 75% mortgages.

  24. Trent Hamm Trent says:

    Pre-mortgage insurance versus private mortgage insurance: our mortgage handler actually used the first term, so that’s what I used in this article. I guess if using the term that a lending professional used “erodes my credibility,” I’m going to have to live with that.

  25. Chandra says:

    I believe that as of 1/1/07 PMI is now tax deductible along with your mortgage interest. Check with your accountant to determine if this is at the federal or your state level.

  26. Hi there,

    As far as I’m concerned, PMI is not an issue anymore. Bank of America’s No Fee Mortgage eliminates PMI for everyone.
    For more information:
    http://residentalieninusa.blogspot.com/2007/05/no-fee-mortgage-from-bank-of-america.html

    My local credit union is also offering a similar program i.e. No PMI.

  27. Trent Hamm Trent says:

    My local credit union beat BoA by almost a full percentage point.

  28. Chris says:

    I tend to think the amount of each loan should be considered as well.

    If I had a car loan of $20,000 at 7%, I would pay just under $1300 the 1st year in interest, $1150 the 2nd, $800 the 3rd, $480 the fourth, and $180 the 5th. That works out to a total of about $3.8k in interest over a 5 year loan.

    If I had a mortgage for 250,000, the .6% PMI interest would equal $1480 the 1st year , $1430 the 2nd year, $1386 the 3rd, $1340 the fourth, and $1290 the 5th. That’s $6.9k in interest the first 5 years of a 30 mortgage.

    After 5 years, I would have built up about 15% equity on the 250,000, not quite out of the PMI woods yet. In fact, I would need to wait until midway through the 7th year to reach the 20% equity of the $250k after almost $9k in interest.

    I would recommend looking at the amount of interest you pay in terms of dollar value, not simply in terms of percentage of the loan.

  29. Ben says:

    Nobody heard of the 80/10/10 loan like I described earlier? I think it’s a much better route to take!

  30. Ben, we did an 80/10/10 and it worked out great.

  31. Lisa says:

    This is very helpful. Thanks everybody for chiming in. Does anyone know if these standards apply to buying a vacation home (well, it would be my ONLY home-keep an apt here) in Mexico? Anyone done business with a US lender to purchase property in another country?

  32. Joshua says:

    There are others ways to avoid the PMI loss that haven’t been pointed out. The problem with PMI isn’t that its any large percentage. The problem is that you are basically setting that money on fire. To figure your calculation on what you save apply the portion you pay for PMI to the principal of your loan for instance.

    There are acutally several other ways to avoid the PMI scam. Your statement: “This usually requires that your house be reassessed and it be shown that you currently owe less than 80% of the value of your home.”
    Is actually only partially correct. Its not what you owe on the house it is what you owe on your primary mortgage.
    The following loans are just an example of ways to get around paying PMI: 80/20, 80/10/10, or 80/15/5 loans. What does this mean? The first number is the amount you finance through a primary mortgage. The second number is an amount you finance through a secondary credit line or second mortgage, the third number is a down payment.

    So for example if your house is 100,000.00 using an 80/10/10 you will finance 80,000.00 on a primary mortgage, 10,000.00 on a secondary mortgage, and 10,000.00 in cash. Another advantage to this is that your equity investment is usually accessible (though I would not advise it). The second advantage is you can effectively lower your payments sooner by paying off your secondary loan first.

    There are ups and downs, and its not for everyone, but there are alot of options available if you know what to look for.

  33. Joshua says:

    Oh and you dont have to refinance to get rid of the PMI you just have to call financer and ask them to assess whether you are at 80% equity. I think legally they are required to assess them themselves as well.

  34. Ben says:

    5Cent-

    Good for you guys. I had never considered that option but when my loaner laid it out for me, side by side with the regular loan with PMI, I couldn’t help but think why the heck don’t people do it this way instead?

  35. James Morgan says:

    Ben, yes I did an 80/10/10 loan too. 10% down, 10% HELOC, and 80% fixed rate. I paid off the 10% HELOC within a year though.

  36. Byron says:

    I hope that not everyone here is automatically planning on deducting the cost of PMI from their 2007 taxes. No one has mentioned that first of all you have to be below a certain income threshold (55K for a single person and 110K for married couples) and that the deduction has to be renewed on a yearly basis. So who knows if it will even be around next year? My wife and I are above that threshold and went through B of A to get a very resonable rate with no PMI while putting 5% down on our Seattle area townhouse. Our monthly payments are much lower than they would have been going the 80/15/5 or 80/10/10 route. We have very good credit and were told by several advisors to avoid HELOCs as it could potentially mess with our credit scores.

  37. Tristan says:

    It is ALWAYS best to pay off your mortgage early. You should have said, pay off smaller debts first then pay off your mortgage.

    A mortgage brings debt and risk into your life. The sooner you can own your home free and clear the better. If someone can’t put 20% down are they really ready and able to afford a home?

  38. Andrea says:

    When considering to take PMI, remember it is now tax deductible if you make under $100,000 a year. If you make more than this the other alternative usually is to take an 80-10-10 or 80-15-5 depending on how much you put down. One mortgage would be an 80% loan, then a second mortgage would be either a 10% or 15% loan at a slightly higher rate, then the last 10% or 5% would be your down payment. My husband and I found in our recent mortgage quest that that 80-15-5 plan worked best for us because we couldn’t take the PMI deduction and the quote from Bank of America we got from their No Fee Mortgage Plus program (which gives you a loan with no PMI) was a wash to the 80-15-5 mortgage.

  39. PT says:

    I’m interested in the other side of this program…the $250 Best Value Guarantee. Has anyone recieved their check yet? I can’t see to get my check.

    I applied for two loan programs (BOA and DHI), was accepted to both. DHI ended up offering the best value. I jumped through all of BOA’s hoops to get the $250 and still haven’t recieved the check. Anyone else having this issue?

    Thanks,

    PT
    Prime:Time:Money
    http:ptmoneyblog.com

  40. tb says:

    I was talked into using an 90/10 mortgage by the mortgage company to avoid PMI. The 10% mortgage rate is 12%. In retrospect paying the PMI would have been cheaper than paying the 12%.

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