When Is Private Mortgage Insurance (PMI) Required?

Private Mortgage Insurance (PMI) is a financial consideration for many individuals purchasing a home. It represents an additional cost that can influence monthly mortgage payments. Understanding when PMI is required and how it functions is important for homebuyers. This insurance helps enable homeownership for those who might not have a substantial down payment readily available.

What is Private Mortgage Insurance (PMI)?

Private Mortgage Insurance (PMI) is an insurance policy designed to protect the mortgage lender, not the borrower, if a borrower defaults on their loan. Lenders typically require PMI when a borrower makes a smaller down payment, usually less than 20% of the home’s purchase price. This scenario presents a higher risk for the lender, and PMI helps offset it, allowing lenders to approve more mortgages. Borrowers typically pay PMI as a monthly premium added to their mortgage payment, though other payment options like an upfront fee or a combination of upfront and monthly premiums may exist.

PMI Requirements for Conventional Loans

For conventional loans, private mortgage insurance is generally required when the borrower’s down payment is less than 20% of the home’s purchase price. This means if the loan-to-value (LTV) ratio, which compares the loan amount to the home’s value, is greater than 80%, PMI will likely be a condition of the loan.

Borrowers can often avoid PMI on a conventional loan by making a down payment of 20% or more. The cost of PMI can vary based on factors like the loan amount, the size of the down payment, the borrower’s credit score, and the loan type. PMI typically remains in effect until the borrower reaches a certain equity threshold in their home.

Mortgage Insurance for Government-Backed Loans

Government-backed loans, such as those from the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), and U.S. Department of Agriculture (USDA), have distinct mortgage insurance requirements that differ from conventional PMI. FHA loans, for example, always require Mortgage Insurance Premiums (MIP), regardless of the down payment amount. This includes an Upfront Mortgage Insurance Premium (UFMIP), currently 1.75% of the base loan amount, typically paid at closing or financed into the loan. FHA loans also have an annual MIP, paid monthly, which varies based on the loan amount, loan-to-value ratio, and loan term. For most FHA loans, if the down payment is less than 10%, the annual MIP is required for the life of the loan; if 10% or more, it is required for 11 years.

Conversely, VA loans generally do not require monthly PMI or MIP. Instead, VA loans typically include a one-time VA Funding Fee, which helps sustain the program. This fee can range from 0.5% to 3.3% of the loan amount, paid upfront or financed into the loan, and some veterans may be exempt. USDA loans also operate without PMI, but they have their own fees: an upfront guarantee fee and an annual fee. The upfront guarantee fee for USDA loans is currently 1% of the loan amount, which can be rolled into the loan, and the annual fee is 0.35% of the loan amount, paid monthly. These fees serve a similar purpose to mortgage insurance by reducing lender risk in specific rural development contexts.

PMI and Refinancing

When homeowners refinance a mortgage, the requirement for private mortgage insurance can re-emerge or continue. If a homeowner refinances a conventional loan and the new loan-to-value (LTV) ratio is greater than 80% (less than 20% equity), PMI will likely be required on the new loan.

Homeowners with an FHA loan who refinance into a new FHA loan will also continue to pay Mortgage Insurance Premiums (MIP), as MIP is a standard component of all FHA loans. However, refinancing an FHA loan into a conventional loan can be a strategy to eliminate MIP, provided the homeowner has built sufficient equity to meet conventional loan LTV requirements, typically at least 20%. The decision to refinance often hinges on the borrower’s equity position and the desire to remove ongoing mortgage insurance costs.