As Mortgage Insurance Gets Cheaper, PMI Becomes Less of a “Dirty Word”
The Conventional Wisdom
The conventional wisdom about private mortgage insurance (PMI) has long been that borrowers should try to avoid it. PMI is a requirement for conventional mortgage borrowers who put down less than 20% on a home — and it’s just one more cost squeezing first-time homebuyers.
Yet, in recent years, private mortgage insurers have lowered their rates.
“I am a big fan of mortgage insurance — and it’s kind of a dirty word,” says Emanuel Santa-Donato, senior vice president at Tomo Mortgage. “When you talk to customers, they don’t tend to like it,” he adds. “But if you look at the actual cost of the mortgage insurance relative to being able to put down 3% or 5%, it is quite advantageous. That money could be used elsewhere.”
What is Private Mortgage Insurance (PMI)?
PMI is a requirement for conventional mortgage borrowers who make a down payment of less than 20% on a home. Although the borrower pays for coverage, PMI protects not the borrower, but the lender. Should the borrower default, or stop paying, the loan, the lender receives a payout from the PMI carrier.
PMI is a temporary expense. By law, lenders are required to cancel it when your mortgage balance drops to 78% of your home’s original purchase value, or when you are halfway through your loan term, whichever comes first.
Does PMI Cost Less Now?
Today, the average cost of private mortgage insurance is about 0.4% of the amount of the loan. If you were paying PMI on a $400,000 loan, for example, your premium would be $1,600 a year, or about $133 a month.
As recently as 2019, borrowers could expect to spend more than that: around 0.5%. In the same scenario, that’d be $2,000 a year, or $167 monthly.
Why Are PMI Rates Falling?
The private mortgage insurance industry is made up of half a dozen carriers, a roster that includes Mortgage Guaranty Insurance Co., Radian Group, National Mortgage Insurance and Arch Mortgage Insurance. Over the past decade, those companies have adjusted their pricing models to more accurately reflect the risk posed by each individual borrower.
“Ten years ago, there were these very formulaic rate cards that each of the PMI lenders gave to the lenders,” says Chris Grimes, senior director at Fitch Ratings. “Now there’s a very dynamic process with hundreds, if not thousands, of factors.”
The new approach allows PMI carriers to more closely match each borrower’s risk profile to the premium.
“Pricing is more granular than it’s been before, and that’s how you get more precise premiums,” says Carl Tyree, chief sales officer at Arch Mortgage Insurance.
Should You Pay PMI?
With home prices at record highs, coming up with a 20% down payment simply isn’t an option for many homebuyers, especially first-time buyers.
If you have enough financial flexibility to choose between a 20% down payment and something lower, though, ask yourself: “What else can you do with the money? Do you want to take that extra equity and invest it?” Santa-Donato says.
Here are two hypotheticals facing the buyer of a $500,000 home:
* Make a 20% down payment of $100,000. Assuming a 30-year mortgage at 7%, your monthly loan payment would be $2,661.
* Make a 10% down payment of $50,000. Your loan amount would go up to $450,000, so your monthly payment would rise to $2,994. Assuming a PMI premium of 0.35%, you’d pay an extra $131 in monthly PMI costs, bringing the total payment to $3,125.
There’s no right or wrong answer. Keeping the extra $50,000 in the bank or in investments would cost you $464 a month — the difference in mortgage payment between the first and second scenario. From there, it’s a personal decision about how much you value liquidity.
Bottom Line
PMI remains an extra expense, but rates have come down enough in recent years that borrowers no longer need to reflexively avoid it.
FAQs
* What is private mortgage insurance (PMI)?
PMI is a requirement for conventional mortgage borrowers who make a down payment of less than 20% on a home.
* How much does PMI cost?
The average cost of private mortgage insurance is about 0.4% of the amount of the loan.
* Can I get rid of PMI?
PMI is a temporary expense. By law, lenders are required to cancel it when your mortgage balance drops to 78% of your home’s original purchase value, or when you are halfway through your loan term, whichever comes first.
* Is PMI worth it?
It depends on your individual circumstances. If you have enough financial flexibility to choose between a 20% down payment and something lower, ask yourself: “What else can you do with the money? Do you want to take that extra equity and invest it?”
