Private mortgage insurance is a fact of life if you put down less than 20% on a conventional loan. Why? Because lenders take on more risk the lower the down payment they accept. Private mortgage insurance (known as PMI) helps to reduce that risk.
But far from being a dirty word for homebuyers, PMI on a conventional loan is actually a good thing. The option to purchase a home for as little as 3% or 5% down provides the flexibility to buy a home much sooner than you could if you had to save up 20%.
And the sooner you buy a home, the faster you can build up equity — one of the biggest factors in wealth creation in the U.S.
What's in this Article?
What is private mortgage insurance (PMI)?
PMI on a conventional loan protects your mortgage lender if you default on your home loan. The annual premium on your private mortgage insurance adjusts every year based on your loan balance.
Your PMI rate is charged as a percentage of your loan, and private mortgage insurance rates typically vary between 0.5-1.5% of the annual loan balance. Rates are calculated based on your credit score and your loan-to-value ratio (LTV), which just means how much you’re putting down vs how much you’re borrowing.
If you put down 3%, your LTV is 97%, since you are borrowing the remaining 97%. If you put down 5%, the LTV is 95%, and so on.
It’s incredibly common for homebuyers to put just 3-5% down on a conventional loan.
Here’s the good news: You only owe PMI if your down payment is less than 20%. And if you put less than 20% down, you only have to pay PMI until you achieve 20% home equity.
At that point, you can request that your lender remove the PMI obligation. Once you reach 22%, the lender removes PMI automatically. However, it is important that you ensure this happens. If it doesn’t happen automatically, submit a written request to your lender to remove PMI.
Having to pay PMI might seem like a drawback to conventional loans. But the benefit to buyers is that they can buy homes with less money up front.
Once you start making your monthly mortgage payments, you’re building equity and your personal wealth — and you’re a step closer to eliminating PMI altogether.
How much is PMI for a conventional loan?
PMI for a conventional loan is calculated based on the home price, loan amount, down payment, and your credit score.
Generally, lower down payments mean higher monthly PMI premiums. Bigger down payments mean lower PMI premiums and less paid out toward mortgage insurance over time.
Related reading: Conventional 97 Loan: How to Qualify for a Low Down Payment Mortgage
Freddie Mac, one of the government-sponsored entities (GSEs) that backs conventional conforming loans, says homeowners should expect to pay between $30-70 a month per $100,000 financed.
Based on that range, a homeowner who borrowers $300,000 from a mortgage lender might pay anywhere from $90 to $210 per month depending on credit score, down payment, and other factors.
Reducing the PMI rate
But to take a more specific example, let’s look at what PMI might look like for a borrower with a 679 score who is taking a 5% down conventional loan.
MGIC, a popular mortgage insurance provider, says this borrower would pay 1.28% of the loan amount per year with this criteria, or about $266 per month on a $250,000 loan.
Here’s where credit score really impacts your PMI rate. If this borrower raised their credit score a single point, to just 680, they would qualify for a more competitive PMI rate of 0.96%.
They could get it down to 0.65% if they boosted their score by a point and increased their down payment to 10%. That’s more than a half apercentage point less than where we started.
Mortgage insurance rates are closely tied to your credit score and down payment, and the lower both of those are, the more you’ll pay. Following are PMI rates at the time of this writing, according to MGIC.
|Borrower 1||Borrower 2||Borrower 3|
All three borrowers made 3% down payments, but the homebuyer with the lowest credit score will pay significantly higher PMI on their conventional loan.
Now let’s see what happens if each of these borrowers increase their down payments.
|Borrower 1||Borrower 2||Borrower 3|
The best rates go to the borrowers with high credit scores and high down payments.
Now, does that mean that if you have a low credit score and cannot afford a large down payment, you’re doomed to paying high mortgage insurance rates?
No. But you may want to consider loan programs that have different types of mortgage insurance and lower mortgage insurance rates. See the next section for conventional loan alternatives.
How do I pay PMI?
Your annual PMI premium is typically divided by 12 and included in your monthly mortgage payments. The annual premium is updated each year based on how much you still owe on the loan.
Do all loans have mortgage insurance?
Conventional loans are not the only home loans that require mortgage insurance. Government-backed loans* also include mortgage insurance stipulations, though the rates and rules are different from those on conventional loans.
FHA mortgage insurance premium (MIP)
FHA loans*, which are backed by the Federal Housing Administration, allow homebuyers to qualify for a mortgage with credit scores as low as 580 with a 3.5% down payment.
However, FHA borrowers must pay an upfront and annual mortgage insurance premium (MIP), and the annual fee remains for the entire loan term if you put down less than 10%. If your down payment is 10% or higher, the annual MIP requirement ends after 11 years.
The upfront FHA MIP is 1.75% of your original loan amount. The annual MIP is 0.85% and is recalculated every year. As with PMI payments, the annual FHA mortgage insurance premium is broken down across your monthly mortgage payments.
You can avoid the annual MIP on an FHA loan by refinancing to a conventional loan once your loan amount is roughly 80% of the home’s current value.
Related reading: Conventional Loans vs FHA: Which Mortgage Is Better?
USDA mortgage insurance
Like FHA loans, USDA home loans require upfront and annual mortgage insurance. The upfront fee on a USDA loan is 1%, and it can usually be financed into the loan, so you may not have to pay it at closing.
The annual mortgage insurance premium is 0.35% of the loan balance, significantly lower than the yearly percentage on conventional or FHA mortgages.
USDA mortgage insurance remains in place for the life of the loan. However, you may be able to refinance to a conventional loan when you reach 20% equity in the home.
Related reading: USDA Loan vs FHA: Which Mortgage Is Right for You?
VA loan funding fee
The U.S. Department of Veterans Affairs, or VA, insures VA loans* to help active-duty servicemembers and retired veterans, as well as eligible spouses, join the ranks of homeownership.
While a VA loan does not require private mortgage insurance, there is a one-time VA loan funding fee charged as a percentage of your loan. The funding fee amount is based on your down payment amount and whether you’ve used a VA loan in the past.
How can I stop paying PMI on a conventional loan?
Once you reach the 80% LTV — meaning you have 20% home equity — you can request that your lender remove the PMI charge. Keep in mind, you have to ask for its removal, your lender does not automatically remove PMI until you reach 22% home equity. Keep in mind that the lender may use the original purchase price as a basis for that equity figure.
For instance, you purchased the home for $100,000 with 5% down. It’s now worth $120,000 and the loan amount is $90,000. Using the current value, you have 25% equity. But if your lender uses the original purchase price, you only have 10% equity and would have to refinance to get out of PMI.
In addition, if your house value went down, don’t be surprised if the lender uses your home’s new, lower value.
Not all lenders and loan servicers use these conservative calculations. But it’s worth exploring other options if the lender says you don’t yet have adequate equity.
To cancel PMI, the borrower must:
- Have at least 20% equity in the home according to the lender’s or servicer’s calculations
- Make the request for PMI removal verbally or in writing to their lender
- Have an on-time payment history with no payment made more than 30 days late in the 12 months prior to the removal request
- Have an on-time payment history with no payment made more than 60 days late in 24 months, or two years, leading up to the removal request
Housing prices go up and down, just like the prices of produce or gasoline. If your local housing market has been heating up and you think your property value has substantially increased, you can request an appraisal to find out if it’s risen enough to push you into the 20% equity bracket earlier than expected.
PMI on conventional loan FAQs
PMI on a conventional loan varies based on the loan amount, down payment, and your credit score. Typically, PMI rates range between 0.5-1.5% of the loan balance, and premiums adjust every year to reflect the update balance.
Yes, you can, once you reach 20% equity. But you have to request — either verbally or in writing — that your lender remove the PMI on your conventional loan. Once you hit 22% equity according to the lender’s calculations, the lender removes PMI automatically.
Private mortgage insurance is required by most lenders when the borrower makes a down payment of less than 20% on a conventional loan.
A trade-off worth making
While PMI on a conventional loan may seem burdensome – it actually allows lenders to approve loans for borrowers who can handle a mortgage payment but cannot save the traditional 20% down payment. Therefore, PMI enables renters to become homeowners sooner than they might have expected.
And that’s critical, because homeownership can be one of the most fulfilling and lucrative endeavors you can undertake.
*Fairway is not affiliated with any government agencies. These materials are not from the VA, HUD, FHA, USDA, or RD, and were not approved by a government agency.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.