6 Reasons to Avoid Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) is an added cost homebuyers must pay if they purchase a home with a down payment of less than 20%. This kind of insurance protects the lender in case the borrower defaults. Unfortunately, for many buyers, a down payment of less than 20% is the only option for buying a home. Learn more about why you should avoid paying PMI, and what you can do to stop paying it sooner.

Six Reasons to Avoid Private Mortgage Insurance (PMI)

1. PMI Is Expensive

The total costs of PMI over the life of the mortgage can be substantial. PMI typically costs between 0.5% to 1% of the entire loan amount annually. For example, you could pay as much as $1,000 a year—or $83.33 per month—on a $100,000 loan, assuming a 1% PMI fee. The amount will vary based on your credit score and loan-to-value ratio.

Paying PMI can be more costly than paying interest on a piggyback second mortgage, which can be used in lieu of a cash down payment. Your actual savings depend on factors like the terms of the loans and cost of PMI, so it’s a good idea to compare the costs.

2. PMI Is Not Deductible

Until 2017, PMI was still tax-deductible, but only if a married taxpayer’s adjusted gross income was less than $110,000 annually. The 2017 Tax Cuts and Jobs Act (TCJA) ended the deduction for mortgage insurance premiums entirely, effective 2018. PMI was deductible during the COVID-19 pandemic but is no longer deductible.

3. PMI Does Not Benefit You or Your Heirs

The lending institution is the sole beneficiary of a mortgage insurance policy, and the proceeds are paid directly to the lender (not indirectly to heirs). You must obtain a separate insurance policy if you want to protect your heirs and provide them with money and a home upon your death. PMI will not provide financial protection to anyone but your mortgage lender.

4. PMI Is a Lost Investing Opportunity

Homebuyers who put down less than 20% of the sale price will have to pay PMI until the home’s total equity reaches 20%. This could take years, and it amounts to a lot of money you pay to protect the lender without a benefit to yourself.

Money spent on PMI could have been invested and earned profits. For example, if a couple who owns a $250,000 home were to take the $208 per month they were spending on PMI and invest it in a mutual fund that earned an 8% annually compounded rate of return, that money would grow to $36,608 within 10 years.

5. PMI Can Be Difficult to Cancel

Usually when your equity in your home reaches 20%, you no longer have to pay PMI for conventional mortgages. However, eliminating the monthly expense isn’t as easy as not sending the payment. Some lenders require you to write a letter requesting that PMI be canceled. They may ask for a formal appraisal of the home. This could take several months, depending upon the lender, during which time PMI still has to be paid.

For some types of loans, like FHA loans, you cannot cancel mortgage insurance. Instead, to remove the mortgage insurance costs, you must refinance the loan or pay it down fully.

6. PMI Payments Are Ongoing

One final issue that deserves mentioning is that some lenders require you to maintain a PMI contract for a designated period. So, even if you have met the 20% threshold, you may still be obligated to keep paying for the mortgage insurance. Read the fine print of your PMI contract to determine if this is the case for you. PMI isn’t automatically canceled until your equity hits 22%.

Consider a Piggyback to Avoid Paying PMI

In some circumstances, PMI can be avoided by using a piggyback mortgage. It works by using two mortgages so that neither mortgage provides for more than 80% of the home’s value.

For example, if you want to purchase a house for $200,000 but only have enough money saved for a 10% down payment, you can enter into what is known as an 80/10/10 agreement. You will take out one loan totaling 80% of the total value of the property, or $160,000, and then a second loan, referred to as a piggyback, for $20,000 (or 10% of the value). Finally, as part of the transaction, you put down the final 10%, or $20,000, in cash.

By splitting up the loans, you can deduct the interest on both of them and avoid PMI altogether. Of course, there is a catch. Often, the terms of a piggyback loan are risky. Some are adjustable-rate loans, contain balloon-paymentprovisions, or are due in 15 or 20 years (as opposed to the more standard 30-year mortgage).

The Bottom Line

PMI is expensive. Unless you think you can get 20% equity in the home within a couple of years, it probably makes sense to wait until you can make a larger down payment or consider a less expensive home, which will make a 20% down payment more affordable. If you are buying a home and have a small down payment amount, consider consulting a financial advisor or mortgage professional to review the options that best fit your situation.