Conventional Mortgage Insurance: How PMI Works and What It Really Costs

One of the biggest misconceptions I hear about conventional financing is that you need a 20% down payment to buy a home.

You don’t.

Conventional financing can allow qualified buyers to purchase a home with significantly less than 20% down. The tradeoff is that when you make a smaller down payment, you’ll typically have private mortgage insurance, commonly called PMI.

But PMI isn’t necessarily something to avoid. In many cases, it can be the tool that allows a buyer to purchase a home sooner without waiting years to save a 20% down payment.

Let’s look at how conventional mortgage insurance actually works.

What Is PMI on a Conventional Mortgage?

Private mortgage insurance protects the mortgage lender if a borrower defaults on the loan.

It’s important to understand that PMI protects the lender, not the homeowner, even though the borrower typically pays the premium.

For many conventional loans, mortgage insurance is generally required when the loan is greater than 80% of the home’s value — in other words, when you’re putting less than 20% down.

How Much Is Conventional Mortgage Insurance?

There isn’t one PMI rate that applies to everyone.

This is one of the biggest differences between conventional mortgage insurance and FHA mortgage insurance.

With conventional financing, the cost of PMI can vary considerably from one borrower to another.

Some of the factors that can affect the cost include:

• Credit score

• Amount of the down payment

• Loan-to-value ratio

• Loan amount

• Loan term

• Property and occupancy type

• Overall loan characteristics

That’s why simply asking, “How much is PMI?” doesn’t always have a simple answer.

We really need to look at the individual loan.

Your Credit Score Can Make a Big Difference

Credit is particularly important with conventional mortgage insurance.

Generally, a borrower with a stronger credit profile may qualify for significantly better mortgage insurance pricing than a borrower with a lower credit score.

For example, two borrowers could each purchase a $400,000 home with 5% down and have very different PMI payments because their credit profiles are different.

And credit may affect more than just PMI.

It can also affect the pricing of the mortgage itself.

That means improving your credit could potentially help you in two places: your mortgage pricing and your mortgage insurance.

This is why I like to evaluate the entire loan rather than simply asking whether someone qualifies.

Do You Have to Put 20% Down on a Conventional Loan?

No.

Depending on the conventional loan program and borrower qualifications, down payments can be much lower than 20%. Some conventional programs even allow eligible borrowers to purchase with as little as 3% down.

Of course, putting more money down reduces the loan-to-value ratio and can potentially reduce or eliminate mortgage insurance.

But that doesn’t automatically mean putting 20% down is the best financial decision.

Is It Better to Put 20% Down to Avoid PMI?

Sometimes. But not always.

Imagine you have enough money available to put 20% down, but doing so would use nearly all of your savings.

Avoiding PMI might save you money each month, but you’d also be moving a significant amount of cash into the house.

Depending on your situation, you may prefer to keep some of that money available for:

• Emergency savings

• Home repairs and improvements

• Moving expenses

• Furniture

• Investments

• Other financial goals

Instead of automatically putting 20% down, I like to compare the options.

What does 5% down look like?

What about 10% or 15%?

How much does the PMI actually decrease at each level?

Sometimes the difference is significant. Other times, a borrower may be surprised by how inexpensive PMI is with a strong credit profile.

The numbers should help make the decision.

Does Conventional PMI Last for the Entire Loan?

This is one of the most attractive features of conventional mortgage insurance.

PMI generally doesn’t have to remain on your mortgage forever.

For many conventional loans on a one-unit principal residence, federal law provides borrowers with the ability to request PMI cancellation once the loan reaches certain requirements, including generally when the principal balance is scheduled to reach 80% of the home’s original value. Automatic termination generally occurs when the scheduled principal balance reaches 78% of the original value, assuming the borrower is current and other requirements are satisfied.

There are important details and exceptions, so homeowners should check the requirements for their specific loan and servicer.

Can Rising Home Values Help You Remove PMI Earlier?

Potentially, but this is where things get more complicated.

Homeowners sometimes assume that if their home increases in value, PMI automatically disappears.

It doesn’t.

Depending on the loan, investor, seasoning requirements and servicer guidelines, you may be able to request PMI removal based on the home’s current value. The lender or servicer may require a new valuation or appraisal, and additional requirements can apply.

So if you’ve owned your home for a while and values in your neighborhood have increased substantially, it’s worth asking your mortgage servicer what options are available.

Monthly PMI Isn’t the Only Way to Structure Mortgage Insurance

Another thing many borrowers don’t realize is that conventional mortgage insurance can sometimes be structured in different ways.

Depending on the loan and available options, mortgage insurance may be paid as a monthly premium, upfront, or through other structures such as lender-paid mortgage insurance.

Each option has advantages and disadvantages.

For example, eliminating a separate monthly PMI payment doesn’t necessarily mean the mortgage insurance is “free.” The cost may instead be reflected elsewhere in the loan’s pricing.

That’s why it’s important to compare the total cost, not simply the monthly PMI line item.

Conventional PMI vs. FHA Mortgage Insurance

This comparison can be particularly important for borrowers deciding between FHA and conventional financing.

FHA mortgage insurance and conventional PMI work differently.

With conventional financing, mortgage insurance pricing can be heavily influenced by the borrower’s credit profile and equity.

FHA uses its own mortgage insurance structure, including an upfront mortgage insurance premium and an annual mortgage insurance premium.

Depending on the borrower’s credit score, down payment and overall financial profile, one program may be considerably more attractive than the other.

A borrower with excellent credit may find conventional PMI surprisingly inexpensive.

Another borrower may discover that FHA provides the better overall payment or qualification strategy.

Neither program is automatically “better.”

Should You Wait Until You Have 20% Down?

Not necessarily.

Suppose you’re considering a $400,000 home.

A 20% down payment would be $80,000.

A 5% down payment would be $20,000.

That’s a $60,000 difference.

The question shouldn’t simply be:

“How do I avoid PMI?”

A better question is:

“What does PMI cost me compared with what I gain by keeping more of my cash?”

That’s a much more useful financial conversation.

Waiting until you have 20% down could make sense. But depending on home prices, your savings rate, your credit profile and the cost of PMI, purchasing sooner with mortgage insurance could also make sense.

The Bottom Line

Private mortgage insurance isn’t automatically a bad thing.

It’s simply one of the costs we evaluate when structuring a conventional mortgage.

The goal isn’t necessarily to eliminate PMI at all costs. The goal is to determine the combination of down payment, interest rate, mortgage insurance, monthly payment and cash remaining after closing that makes the most sense for you.

Sometimes that’s 20% down with no mortgage insurance.

Sometimes it’s 10%.

Sometimes it’s 5%.

And for some eligible borrowers, it could be 3%.

Before deciding how much money to put down simply to avoid PMI, it’s worth comparing the actual numbers.

A good mortgage strategy isn’t just about getting approved. It’s about deciding how to use your money most effectively.