Mortgage insurance cost versus benefits: Should you pay for PMI?

Tim Lucas
The Mortgage Reports editor

Mortgage insurance isn’t a bad thing

Private mortgage insurance (PMI) is usually required if you put less than 20% down on a house. 

Many homebuyers try to avoid PMI at all costs. Why? Because unlike homeowners insurance, mortgage insurance protects the lender rather than the borrower.

But there’s another way to look at it.

Mortgage insurance can put you in a house a lot sooner.  You might pay more than $100 per month for PMI. But you could start earning upwards of $20,000 per year in home equity.

For many people, PMI is worth it. It’s a ticket out of renting and into equity wealth.

Check your home loan options (Apr 19th, 2021)

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What is mortgage insurance?

PMI — private mortgage insurance — is a type of insurance policy that protects mortgage lenders in case borrowers default on their loans. Here’s how it works.

If a borrower defaults on their home loan, it’s assumed the lender will lose about 20% of the home’s sales price.

If you put down 20%, that makes up for the lender’s potential loss if your loan defaults and goes into foreclosure. Put down less than 20%, and the lender is likely to lose money in the event of a foreclosure.

That’s why mortgage lenders charge insurance on conventional loans with less than 20% down.

Mortgage insurance covers that extra loss margin for the lender. If you ever default on your loan, it’s the lender that will receive a mortgage insurance check to cover its losses.

That might sound like a tough deal. But the upside is, mortgage insurance gives you a fast track to home ownership.

Without mortgage insurance, many people would have to wait years to save up for a bigger down payment before buying a house.

Those are years they could have spent investing in their home and building equity — rather than paying rent to a landlord each month.

Verify your home buying eligibility (Apr 19th, 2021)

How much is mortgage insurance?

Mortgage insurance costs vary by loan program (see the table below). But in general, mortgage insurance is about 0.5-1.5% of the loan amount per year.

So for a $250,000 loan, mortgage insurance would cost around $1,250-$3,750 annually — or $100-315 per month.

Mortgage insurance rates

Note that for most loan types, there are two mortgage insurance rates: an annual rate and an initial rate or “fee.”

The initial mortgage insurance fee is usually higher, but it’s only paid once when the loan closes. And both types of mortgage insurance vary by loan program.

  Conventional Loans FHA Loans USDA Loans VA Loans
Initial Mortgage Insurance n/a “Upfront Mortgage Insurance Premium” “Upfront Guarantee Fee” “Funding Fee”
Rate* n/a 1.75% 1.0% 2.3%**
Annual Mortgage Insurance “PMI Annual Premium” “Mortgage Insurance Premium” “Annual Fee” n/a
Rate* 0.19-1.86% 0.85% 0.35% n/a

*Mortgage insurance rates are shown as a percentage of the loan amount

**VA funding fee is 2.3% for first-time use, and 3.6% for subsequent uses

Cost of mortgage insurance by loan type

Each loan type has a different mortgage insurance rate. So even for the exact same loan size, mortgage insurance costs could be very different depending on whether you got a conventional mortgage, FHA, VA, or USDA mortgage.

For example, say you buy a $300,000 home with 3.5 percent down*. Here’s how mortgage insurance costs would compare for the four major loan types:

  Conventional Loan FHA Loan USDA Loan VA Loan
Initial Mortgage Insurance Cost $0 $5,000 $2,900 $6,700
Annual Mortgage Insurance Cost (Paid Monthly) $3,500 $2,500 $1,000 $0
Monthly Payment $280 $200 $84 $0

The above example assumes a $300,000 home purchase with 3.5% down, and a 30-year fixed interest rate of 3.75%. Your own rate and mortgage insurance costs will vary

*Annual mortgage insurance cost is calculated based on year 1 loan balance. Annual costs will go down each year as the loan balance is reduced

Verify your home buying eligibility (Apr 19th, 2021)

How is mortgage insurance calculated?

Mortgage insurance is always calculated as a percentage of the mortgage loan amount — not the home’s value or purchase price.

For example: If your loan is $200,000, and your annual mortgage insurance is 1.0%, you’d pay $2,000 for mortgage insurance that year.

Since annual mortgage insurance is re-calculated each year, your PMI cost will go down every year as you pay off the loan.

For FHA, VA, and USDA loans, the mortgage insurance rate is pre-set. It’s the same for every customer (see the table above).

Conventional PMI mortgage insurance is calculated based on your down payment amount and credit score.

Typically, the ongoing annual premiums for mortgage insurance are spread across 12 monthly installments. You simply pay it each month as part of your regular mortgage payment.

Calculating mortgage insurance by credit score

The following chart compares cost differences between the three major types of mortgage insurance, based on a $250,000 loan amount, and varying credit levels.

  660 FICO Score 700 FICO Score 740 FICO Score
Conventional 5% Down $295 $180 $120
Conventional 10% Down $210 $125 $85
FHA 3.5% Down $175 $175 $175
USDA 0% Down $75 $75 $75

Check your mortgage insurance rates (Apr 19th, 2021)

Cost versus benefit of private mortgage insurance

PMI Comparison Of Equity Position

Today’s homeowners are building wealth like few times in history.

According to the Federal Housing Finance Agency (FHFA), home values in the third quarter of 2020 were up more than 7% from the same period one year prior.

The typical U.S. homeowner is earning $13,000 per year.

What’s more, home value appreciation is nothing new. FHFA says home prices have increased by about 5% per year since 2012. And home values have increased every quarter dating back to 2011.

That means a renter who bought the ‘average’ home four years ago has gained more than $40,000 in home equity to date. Some have earned much more — six figures in some cases.

What’s surprising, then, is “advice” saying you should buy a home only when you have a 20% down payment.

Putting 20% down is less risky than making a small down payment, but it’s also costly.

Even strong opponents of mortgage insurance find it hard to argue against this fact: PMI payments, on average, yield a huge return on investment.

PMI return on investment

Home buyers avoid PMI because they feel it’s a waste of money.

In fact, some forego buying a home altogether because they don’t want to pay PMI premiums.

That could be a mistake. Data from the housing market indicates that PMI yields a surprising return on investment.

Imagine you buy a house worth $233,000 with 5% down.

The PMI cost is $135 per month according to mortgage insurance provider MGIC. But it’s not permanent. It drops off after five years due to increasing home value and decreasing loan principal.

Remember, you can cancel mortgage insurance on a conventional loan when your mortgage balance falls to 80% of your home’s purchase price. 

The homeowner’s snapshot at the end of year 5 looks like this:

  • Current value: $276,000
  • Principal remaining: $200,000

In five years, the home has appreciated $43,000, and the final PMI cost is $8,100. That’s a 5-year return on investment of 530%.

It’s nearly impossible to make that kind of return in the stock market, retirement account, or another financial instrument.

PMI, then, can be viewed as an investment — a very sound one — and not a waste of money.

Use PMI as a wealth-building tool

Homeownership is the primary means of wealth building in the U.S. Each monthly mortgage payment can be considered an investment in the future.

Owning a home is no path to quick riches. Rather, it’s an investment that pays off gradually over time, even considering cyclical downturns.

Long-term housing data supports this fact.

According to the government lending agency FHFA, home real estate values are up more than 140% since 1991. That means a home worth $100,000 in January 1991 is worth $240,000 today.

Over that time, inflation has risen 75%, says the Bureau of Labor Statistics. A first-time home buyer in 1991 has beaten inflation, plus made an additional 65% return on investment.

Inflation-adjusted return is a tangible way to look at wealth increases, but there are non-tangibles, too.

For instance, a homeowner who purchased a home in 1991 is likely near the end of their 30-year fixed mortgage. Soon, the homeowner will be mortgage-free. Their cost of living will drop.

The owner holds a considerable asset, too.

Yet, a person who chose to rent in 1991, and continued to do so, now pays ever-increasing rental prices.

Worse, it’s likely this person has no sizable asset unless he or she has contributed to a retirement account or other investment consistently over two or three decades. Many have not been this forward-thinking.

A house is a forced savings account. Housing expenses are required whether you rent or own. But when you own, you deposit a small chunk toward your future wealth each month.

So what does PMI have to do with this? It starts the wealth-building process sooner. You can be on the winning side of rising home values.

What it costs to avoid PMI

Assume a different homebuyer followed “best practices” as recommended by many financial and housing advisors today.

The buyer chose to avoid PMI. Instead, he or she opts for a 20% down payment: 15% more than the buyer who chose PMI.

The buyer has some saving to do.

He or she budgets and plans to accumulate $10,000 per year toward the goal — difficult but doable. In three and a half years, the buyer raises the full 20% down payment.

But not quite.

He or she is now chasing higher home prices. In 3.5 years, home prices will have risen nearly 13% — factoring in compound interest — or around $30,000.

The buyer no longer needs 20% down based on home prices of three years ago. He or she needs 20% of the current home price.

That’s an additional $6,000.

The increase pushes out the buyer’s time frame. He or she must save four years to put 20% down. During that time, the home buyer forfeits $34,000 in potential home equity.

Add up lost equity and extra down payment costs, and waiting to buy has cost this buyer $32,000 — even after considering the PMI expense he or she “avoided.”

There are many good reasons to delay buying a house, such as saving up closing costs or improving a credit score to avoid higher interest rates. But skipping PMI is not one of them.

Verify your home buying eligibility (Apr 19th, 2021)

PMI with direct-to-buyer benefits

PMI benefits the buyer indirectly, but some mortgage insurance companies now offer buyers direct value, too.

One PMI provider, Radian, layers its MortgageAssureSM product on top of its standard PMI coverage. This program offers job loss protection for the buyer.

The insurance covers the borrower’s payments — up to $1,500 per month for six months — in the case of a job loss during the first two years of the loan.

The program comes at no additional cost for home buyers who make a down payment between 3-5% on some loan programs.

This is peace of mind for the homebuyer and a very good reason to check which PMI providers your lender works with rather than accepting the PMI rates and providers the lender assigns by default.

Mortgage lenders often work with three to five PMI providers. Most often, the lender will choose your provider for you. The choice is often arbitrary or based on who the lender is accustomed to using.

But the borrower can have a say in the matter. If you know of a PMI provider that offers a certain benefit, don’t be afraid to ask for it.

The small request could end up making a big difference later on.

When can I cancel PMI?

PMI cancellation should happen automatically when your loan balance falls to 78% of your home’s original purchase price.

However, you may be able to cancel PMI a little sooner — when you reach the 80% threshold — by contacting your loan servicer.

Keep in mind that these rules apply only to conventional loans. Mortgage insurance works differently for subsidized loans such as USDA and FHA mortgages.

FHA mortgage insurance premium (MIP)

FHA loans, backed by the Federal Housing Administration, require their own type of mortgage insurance. This is known as mortgage insurance premium, or MIP.

MIP charges two separate fees: an upfront payment and an annual one

  • Upfront mortgage Insurance Premium (UFMIP) costs 1.75% of the loan amount. It can be paid at closing but most home buyers roll it into the loan balance
  • Annual mortgage insurance premium (MIP) costs 0.85% of the loan amount per year, split up into 12 installments and paid monthly with the mortgage payment. This is due the life of the loan unless you put at least 10% down. In that case, the MIP payments will cancel after 11 years

Of course, a homeowner could refinance out of an FHA mortgage to get rid of their MIP payments. If the home’s loan-to-value ratio has fallen below 80%, refinancing into a conventional loan could help eliminate MIP later on.  

USDA and VA loans

USDA loans also charge both an upfront and ongoing mortgage insurance fee. However, USDA mortgage insurance rates are slightly lower, with a 1% upfront fee and 0.35% annual charge.

VA Loans, backed by the federal Department of Veterans Affairs, do not require ongoing mortgage insurance payments. The VA charges a funding fee upfront to help insure lenders, but there’s no added monthly charge for the borrower.

How do I know if PMI is right for me?

Private mortgage insurance isn’t for everyone, but home buyers should check potential returns before they automatically refuse it.

Check your home loan options to see what you can afford and how much mortgage insurance would actually cost you.

Verify your new rate (Apr 19th, 2021)