What is PMI and How Does It Affect Home Buyers?

When buying a home for the first time, there are all kinds of things you must learn in a short period of time. It can feel a bit overwhelming as you evaluate your options and try to make good decisions.

One of the terms you may hear when trying to buy a home for this first time is “PMI,” which stands for “private mortgage insurance.” 

We are all familiar with the term “insurance.” In your daily life, insurance is usually something that protects you. For example, health insurance protects you in case of medical emergencies. Automobile insurance protects you in case of a car accident or natural disaster that damages your car. 

But with private mortgage insurance, there’s a twist: you’re not the one being protected. Below, we explain what exactly PMI is, how much it costs, and what the alternatives are

What Is Private Mortgage Insurance (PMI)?

Okay, so if PMI doesn’t protect you, then who does it protect? The answer is… your mortgage lender. In other words, it protects the bank, credit union, or other entity from whom you’re borrowing money. 

It’s easy to forget that your lender is taking on some risk by making a large home loan to you. While mortgage lenders can make a nice profit by lending to home buyers, there is a certain amount of risk that comes with each new loan that’s issued.

After all, there are a number of different things that could go wrong and make it impossible for you to pay back your mortgage. These include unexpected health problems, extended unemployment, or as we’ve seen recently, a global pandemic. 

While it’s not pleasant to think about this, your lender has systems in place to protect themselves in such cases. One of those systems is private mortgage insurance. 

Typically, private mortgage insurance is required for borrowers who put down less than 20% of the home’s value when being approved for the loan. The smaller down payment equals more risk for the lender, so private mortgage insurance is an additional protection. 

Unfortunately, private mortgage insurance requires you to pay the monthly premium. This can add anywhere from ten dollars to a few hundred dollars to your mortgage payment. 

How Much Does Private Mortgage Insurance (PMI) Cost? 

So how much does this insurance premium cost you? Well, that depends on how big your loan is, how high your credit score is, and how much of a down payment you have. 

In general, you can expect to pay about 0.5% to 1% of the loan amount toward PMI every year. So if you have a $120,000 loan, you might pay $600 to $1,200 per year or $50 to $100 per month for PMI. 

To get a more detailed estimate, you must consider all the factors that go into your PMI calculation. The chart below shows what you might expect to pay depending on a few variables: 

Home Price Down Payment Credit Score Est. Monthly PMI
$100,000 3.5% 760 $50
$100,000 3.5% 660 $125
$200,000 10% 760 $50
$200,000 10% 660 $135
$300,000 10% 760 $135

Fortunately, PMI is only required until you’ve built enough equity in the house to equal exactly 20% of the home’s value.

After you have made enough mortgage payments to have that much equity, you can call up your lender and ask them to remove PMI from your loan. 

If you forget to request this change, the lender can continue charging you PMI every month until you’ve build up 22% equity in the home. At that time, the lender is required by law to cancel your private mortgage insurance. 

Is There Any Way To Avoid Private Mortgage Insurance (PMI)? 

There are a few ways to avoid paying PMI. The most obvious way is to put down 20% when you buy the home, but of course this is not an option for many people.

So, if you don’t have 20% to put down, then what? Well, there are a few other options. 

One option is to use a “piggyback loan,” which is a second loan on top of the primary mortgage loan. While this works for some borrowers, it’s not necessarily a good idea because the interest rates can be high and you may end up paying even more than you would have with PMI in the long run. 

Another option is using a “co-investment” or “shared equity” program. With these programs, you give up some of the future appreciation in your home’s value to an outside investor who provides you with cash up front for your down payment. While this can save you money in the short-term it can also cost a lot in the long-term, so home buyers should think carefully before proceeding. 

Consider Partnering with Divvy 

Divvy Homes is a great option for anyone who wants to become a homeowner but who can’t afford PMI or who needs more time to save up for the down payment.

With Divvy, you can move into the home of your choice today and pay Divvy a monthly payment to live in it. We send a portion of your monthly payment to a savings account that you can use to buy the home from us in 3 years or less.

In fact, our program is set up to ensure that you’ll have enough money saved up for a 10% down payment to buy the home within 3 years. Sound interesting? Click here to learn more about Divvy and talk to our team. 


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