Private Mortgage Insurance

Private mortgage insurance (PMI) is insurance that borrowers must pay when they put down less than 20% on a home purchase. PMI protects the lender against losses if the borrower defaults; it does not protect the borrower. Once the borrower has built 20% equity, they can request PMI removal.

Why PMI exists

When a borrower puts down less than 20%, the loan-to-value (LTV) ratio exceeds 80%. This is riskier for lenders: the borrower has less skin in the game (smaller equity cushion), and if the borrower defaults, the lender’s recovery may be insufficient.

PMI transfers this risk from the lender to an insurance company. If the borrower defaults and the home sells for less than the remaining loan balance, the PMI insurer covers the lender’s loss (up to the policy limit).

This allows lenders to originate loans with <20% down, which would otherwise be too risky.

PMI cost structure

PMI is typically priced as an annual premium, expressed as a percentage of the loan amount:

• LTV 90–95%: 1.5–2.0% annually
• LTV 85–90%: 1.0–1.5% annually
• LTV 80–85%: 0.5–1.0% annually

Credit score also matters: A borrower with a 760+ FICO might pay 0.5% on a 90% LTV loan. A borrower with a 620 FICO might pay 2.5% on the same loan.

Example: $300,000 loan with 10% down ($30,000), LTV 90%, credit score 740.

• PMI annual premium: ~1.5% × $270,000 = $4,050
• Monthly PMI: ~$337.50 (rolled into the $1,432 payment)

Over a typical 30-year loan, PMI costs $50,000–150,000+, a significant lifetime cost.

Upfront PMI vs. annual PMI

Upfront mortgage insurance premium (UFMIP): A one-time fee at closing, typically 1.75% of the loan. On a $270K loan, UFMIP is $4,725, either paid in cash at closing or rolled into the loan.

Annual mortgage insurance premium (annual MIP): A recurring fee divided into monthly payments.

Lender-paid mortgage insurance (LPMI): The lender pays the insurance premium upfront and passes the cost to the borrower via a higher interest rate (typically 0.5–1% higher). This avoids a separate monthly payment but increases the total interest paid over the loan.

PMI removal and cancellation

Once the borrower builds 20% equity (either through payments or home appreciation), they can request PMI removal.

Automatic removal: Federal law (Homeowners Protection Act of 1998) requires lenders to automatically cancel PMI when the loan balance reaches 78% of the original home value (22% equity) through principal payments alone.

Request removal: Borrower can request PMI removal once they reach 20% equity by providing evidence (appraisal showing appreciation, amortization schedule showing 20% equity from payments).

Some lenders are reluctant to remove PMI even when the borrower qualifies, requiring the borrower to formally request removal.

PMI versus FHA mortgage insurance

PMI (on conventional loans) and FHA mortgage insurance (on FHA loans) serve similar purposes but have different terms:

FHA loans have higher total lifetime insurance costs because MIP cannot be removed. Conventional loans are cheaper long-term if the borrower plans to hold for 5+ years (PMI gets removed).

Strategies to avoid or minimize PMI

1. Save for 20% down: The simplest way to avoid PMI entirely.

2. Use an 80/10/10 mortgage: Borrow 80% with a conventional loan (no PMI), 10% via a home equity line (HELOC), and put down 10% cash. Avoids PMI but the HELOC is a second lien.

3. Lender-paid mortgage insurance (LPMI): Pay a higher rate but avoid monthly PMI. Makes sense if holding short-term.

4. Wait for home appreciation: Buy with 10% down, pay PMI, and once the home appreciates enough to reach 20% equity, remove PMI. Relies on appreciation.

PMI and the bond market

PMI insurance policies are often packaged into securities and sold to investors (similar to mortgage-backed securities). This creates a secondary market for PMI, ensuring PMI insurers can manage their risk by diversifying.

Market cycles and PMI availability

During credit expansions, PMI is cheap and abundant. During credit contractions (2008–2009, 2020), PMI insurers can face massive claims if home prices fall and borrowers default. Some PMI insurers become insolvent; others raise rates sharply or limit new business.

This affects borrowers: in tight markets, PMI becomes very expensive or unavailable, forcing lenders to require larger down payments.

See also