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Buying a home is an exciting milestone, but saving up for the down payment can be a major hurdle for many buyers This is where private mortgage insurance (PMI) comes in – allowing you to buy with less than 20% down while offsetting some risk for the lender. But how exactly does PMI work, and does it help pay down your mortgage principal?
In this comprehensive guide we’ll break down what PMI is who it benefits, how it impacts your payments and equity, and strategies to get rid of it.
What is PMI?
PMI stands for private mortgage insurance. It’s an insurance policy you’re required to buy if you make a down payment of less than 20% on a conventional mortgage.
Conventional mortgages are loans that are not backed by the government. PMI protects the lender – not you – in case you fail to make your mortgage payments.
Here’s a quick rundown of how it works:
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You buy a home with a down payment of less than 20% of the purchase price.
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The lender sees you as a higher risk because you have less equity invested.
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So the lender requires you to pay for PMI to offset their risk.
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PMI premiums are added to your monthly mortgage payments.
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If you default, PMI reimburses the lender for their losses. You still face foreclosure.
The amount you pay for PMI depends on factors like your loan amount, credit score, and down payment percentage. Rates typically range from 0.5% to 1.5% of the total loan amount per year.
Does PMI Go Towards Your Principal?
The short answer is no. Your PMI payments do not get applied to the principal balance of your mortgage.
The principal is the actual amount you borrowed from the lender to buy the home. PMI does not help you pay this amount down or build equity.
Instead, PMI simply covers potential losses for the lender. It’s like any other insurance premium you pay for coverage.
So while PMI may allow you to buy with less cash up front, it does not accelerate your equity accumulation in any way. Your regular mortgage payments are what slowly whittle away at the principal over time.
How Does PMI Affect Home Equity?
PMI has an indirect impact on your equity by prolonging the time it takes you to reach 20% equity and cancel PMI.
Home equity is the difference between what your home is worth and what you owe on your mortgage. The more principal you pay off, the more equity you build.
With PMI, you aren’t paying extra towards the principal, you’re just paying added insurance costs. This means:
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Your loan balance declines slower with PMI payments vs. without.
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It takes longer to build 20% equity in the home to eliminate PMI.
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You continue paying monthly premiums for a longer period.
The bottom line is PMI equates to higher monthly costs and slower equity growth, which equals less money in your pocket long-term.
Strategies for Canceling PMI
The good news is PMI isn’t necessarily a permanent cost. Here are some strategies for removing it:
Make a larger down payment upfront
Putting at least 20% down avoids PMI altogether from the start. This saves you money on monthly premiums.
Pay down your mortgage faster
Making extra principal payments helps you reach 20% equity faster to request PMI cancellation.
Refinance your loan
If rates have dropped, refinancing could lower your balance enough to eliminate PMI.
Request cancellation at 78% LTV
Even if you don’t proactively request it, your lender must remove PMI when you reach 78% loan-to-value ratio.
Increase your home’s value
As your home appreciates, your equity grows. Home improvements or a hot real estate market can help.
Key Takeaways
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PMI protects the lender, not you, by covering losses if you default.
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PMI payments do not reduce your mortgage principal or help build equity.
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PMI indirectly slows equity growth by adding to monthly costs.
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Make a 20%+ down payment or reach 78% LTV to cancel PMI and avoid premiums.
While PMI allows you to buy with less cash up front, it comes at a long-term cost. Understanding how it works is key to strategizing how to eliminate it quickly and pay off your mortgage faster.
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When does PMI go away?
The Homeowners Protection Act of 1998 (HPA) requires that mortgage lenders or servicers automatically cancel PMI when the mortgage’s loan-to-value (LTV) ratio reaches 78 percent of the home’s purchase price, or the month after you reach the loan term’s midpoint — for example, 15 years on a 30-year loan. Mortgage Icon PMI vs. MIP
PMI applies to conventional loans. If you receive an FHA loan from the Federal Housing Administration, you’ll pay for a different kind of a policy, called a mortgage insurance premium (or MIP). Though it has a similar function, you must pay for MIP no matter how much you put down on an FHA loan, and in many cases, you’ll pay it for the life of the loan. The exception: If you take out an FHA loan now and put down at least 10 percent, you’ll pay MIP for only 11 years. You can also refinance to a conventional loan to get rid of MIP.
Refinance your mortgage
If mortgage rates have decreased, refinancing to a new loan with a lower balance could help you reach the PMI cancellation window sooner. Refinancing costs money, however, and it typically only makes sense if you can lower your interest rate. Learn more:
How Do Principal Payments Work On A Home Mortgage?
FAQ
Where does the PMI money go?
PMI is insurance for the mortgage lender’s benefit, not yours. The coverage will pay a portion of the balance due to the mortgage lender in the event you default on the home loan.
Does PMI go towards anything?
Private mortgage insurance (PMI) is part of the borrowing costs you typically pay to your lender for a conventional loan if your down payment is less than 20%. It’s required by lenders to protect themselves against potential losses that may come from a borrower defaulting on their loan.
Do you get your PMI money back?
No you absolutely will not… pmi is an insurance premium. You don’t get your premiums back when your policy expires, that’s just not how this works.
Who does PMI get paid to?
Private mortgage insurance (PMI) is an extra expense for conventional mortgage borrowers who put less than 20 percent down for a home. Although the borrower pays for it, PMI actually protects the lender, compensating for the extra risk the lender assumes by extending a larger loan with a lower down payment.
What is PMI insurance and how does it work?
PMI (Private Mortgage Insurance) is a type of insurance that protects the lender in case a borrower defaults on a conventional loan. The institution underwriting the mortgage handles the insurance, but the borrower pays the premium.
What does PMI mean in a mortgage?
PMI stands for private mortgage insurance. This is an additional fee, on top of your principal and interest, escrow, and taxes, that you might be required to pay each month. It is used with conventional loans and is a type of insurance that protects the lender in case a borrower defaults on the loan.
Does paying PMI build equity in a home?
Your PMI (Private Mortgage Insurance) payment does not go into building equity in your home. Unlike the principal of your loan, it’s not money you can recoup with the sale of the house, it doesn’t reduce your loan balance, and it’s not tax-deductible like your mortgage interest.
Do you need PMI if you put down a lower amount?
When you put down a lower amount, a lender will consider the loan as a riskier investment and require that the homebuyer buy private mortgage insurance (PMI) with a premium that will be included in the monthly mortgage payments. What Is PMI in Real Estate?
Do I need PMI If I’m behind on my mortgage payments?
Usually, you pay for PMI monthly as part of your mortgage payment. The insurance does not prevent you from facing foreclosure or experiencing a decrease in your credit score if you get behind on mortgage payments. The lender requires PMI because it is assuming additional risk by accepting a lower amount of upfront money toward the purchase.
Why should I not take on PMI?
Here’s why you should not take on Private mortgage insurance (PMI). PMI is not a mandatory cost for all homeowners. Lenders charge PMI when you finance more than a certain percentage of the home purchase. Most of the time, your lender will impose PMI when you put down less than 20%.