When a homebuyer makes a down payment of less than 20%, most lenders require that the borrower pay private mortgage insurance (PMI) until they’ve covered 20-22% of the cost of the home and are no longer considered high-risk. Simply put, PMI is designed to protect the lender’s investment. PMI costs can range from 0.25% to 2% of your mortgage balance annually.
While PMI is an added expense many would prefer to avoid, the reality is that many people simply cannot afford 20% down, while others would rather prioritize being able to afford repairs, renovations, and emergencies.
If you’re putting down less than 20% on a new home, it helps to understand the different types of private mortgage insurance available to you.
1. Borrower-Paid Mortgage Insurance (BPMI) is the most common type of PMI. There’s no cost upfront. It is simply added to your monthly mortgage payments. You pay every month until you’ve paid 22% of the purchase price. At that point, the lender automatically cancels BPMI. If you have a consistent payment history, you can also get proactive and request a cancellation once you’ve paid off 20%
2. Single-Premium Mortgage Insurance (SPMI) takes the form of an upfront lump sum payment rather than monthly payments. The borrower either pays PMI in full during closing or else has it financed into the mortgage. This option offers lower monthly payments than other types of PMI. That said, if you move or refinance in a few years, the lump sum is nonrefundable. Not to mention, if you can’t put down more than 20% to begin with, you may not be able to afford SPMI.
3. Lender-Paid Mortgage Insurance (LPMI) is also paid upfront, but by the lender rather than the borrower. The catch is that the lender raises your interest rate slightly, which you end up paying for over the entire life of your loan. This means that even if you reach 20% equity, your rate won’t go down. Refinancing is the only way to lower your monthly payments. The benefit here is that your monthly payments may still be lower than making monthly BPMI payments, which might enable you to borrow more and/or qualify for a larger home.
4. Split-Premium Mortgage Insurance is the least common type of PMI. It lets you pay part of your PMI upfront and the rest in monthly installments. Borrowers need not come up with as much cash upfront as they would with SPMI, nor do they need to increase their monthly payments by as much as they would with BPMI. You can either ask the lender to pay the upfront portion of the premium, or else fold it into the mortgage. Split premiums may be partly refundable once PMI is canceled.
5. Federal Home Loan Mortgage Protection (MIP) is required for all FHA loans—even if you put down more than 20%. MIP includes both a monthly rate and an upfront payment. If you put down more than 10% initially, you can remove MIP from your loan, but only by refinancing, and only after 11 years.
Bottom line: paying less upfront means more risk for lenders, which in turn means paying PMI—one way or another. If you’re on the market for a home, be sure to research all your options, and, if you need a little guidance, consider reaching out to a qualified mortgage broker.