What this article covers
Opher Ganel explains why private mortgage insurance, required when a mortgage exceeds 80% of a home’s value, protects your lender rather than you, since the PMI provider can pursue you for whatever it pays the lender after a foreclosure. His worked example shows PMI costing $25,470 over about five and a half years, and how splitting the loan into an 80% first mortgage plus a second mortgage cuts that cost by 61% to more than 92%.
Key Takeaways
Private mortgage insurance protects your lender, not you
PMI is required when a single mortgage is more than 80% of the home’s appraised value. If you default and the foreclosure sale doesn’t cover the balance, the PMI provider pays off your lender, then, as Opher Ganel points out, turns around and pursues you for what it paid.
PMI can cost tens of thousands of dollars before you can drop it
In Opher’s example (a $226,800 home, 10% down, a 3.75% 30-year fixed loan and PMI at 2.25% of the original balance), PMI runs $383 a month and $25,470 over about five and a half years. That’s more than 5.3% of the total cost of buying the home, including principal, interest, taxes, PMI and homeowners insurance.
Two mortgages instead of one can avoid PMI at a fraction of the cost
PMI is triggered by a single loan above 80% loan-to-value, not by your total loan-to-value, so an 80% first mortgage plus a second loan for the rest avoids it. With the second loan at 5.75%, the extra cost is $27.32 a month: $9,835.20 over 30 years (more than 61% less than the PMI) or about $1,967 if you sell after six years (more than 92% less).
When we bought our first home, we couldn’t afford the recommended 20% down payment. Heck, we could barely afford to bring $10,000 cash to the closing table.
Since this was our first time getting a mortgage, here’s all we knew about mortgages:
- We needed one to be able to pay for the house and closing costs
- The lower the interest rate, the better
- We’d have to pay the lender each month for 30 years (or until we sold the house, whichever happened first) or we’d lose the house
What Is Private Mortgage Insurance (PMI), and Who Does It Protect?
In the US, if you buy a home and take out a mortgage for more than 80% of the home’s appraised value, you’re legally required to buy something called Private Mortgage Insurance. PMI for short.
PMI works like this: each month, as part of your mortgage payment, you pay some extra to the PMI provider. In return, if you default on your mortgage, your lender will foreclose on your house and sell it to get as much as possible to pay off your loan. If the market dropped and the mortgage has a remaining balance after foreclosure, the lender will go to the PMI provider and have them pay off what you still owe. So far so good, right? This means your lender won’t go after you for money you don’t have. Here’s where it isn’t so good…
Once the PMI provider pays off your lender, they turn around and pursue you for what they just paid. Say what?! That’s like your auto insurance carrier paying off someone you hit, and then suing you for what they paid! Crazy!
How Much Does PMI Cost? A Worked Example
The cost of PMI varies a lot. Currently, according to NerdWallet, it’s between 0.55% and 2.25% of the original loan amount per year. This continues until you owe less than 80% of the home’s value and request that the PMI stop. The reduction in so-called loan-to-value (LTV) ratio can results from your home’s value going up (or it could actually get worse if the home value goes down). If the local real estate market is stable, your LTV will only decrease slowly as you gradually pay down the principal of the mortgage.
To see how much your PMI can cost you, let’s use the NerdWallet calculator with the following assumptions:
- You’re buying a home that costs the median home value in the US, currently $226,800
- You pay a 10% down payment of $22,680
- You get a 3.75%-interest, 30-year-fixed mortgage to cover the rest of the home’s price
- You pay each month the minimum required to pay off the mortgage in 30 years
- The PMI is at the high end, at 2.25% of the original mortgage balance
Your monthly PMI payment will be $383. By the time you can remove the PMI, after about five and a half years, you will have paid a total of $25,470!
That’s over 5.3% of your total cost for buying the home, including mortgage principal, interest, taxes, PMI, and home-owners insurance! And that’s for something that protects your lender but doesn’t do anything for you! Isn’t that insane?
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How to Avoid PMI Without a 20% Down Payment by Using Two Mortgages
Going back to when we bought our first home, we were lucky enough to work with a great lender. It was he who recommended that instead of getting a 95%-LTV mortgage, we get two mortgages. The first would cover 80% of the home’s value, and the second would cover what the first loan and our down payment didn’t cover.
The great thing with this scenario was that we didn’t take out a mortgage for more than 80% LTV. PMI isn’t required when your total LTV (or TLTV) is above 80%. Just if there’s a single loan with LTV above 80%.
A second mortgage may have interest rates about 1-2% higher than your first mortgage. That makes sense, because if you default, the lender of the second mortgage doesn’t get anything until the home is sold and the lender of the first mortgage is fully paid off. This means that the second loan’s lender is taking on higher risk, so they’ll charge higher interest.
Second Mortgage vs. PMI: Why Two Loans Can Cost Far Less
As of this writing, you could get a Home Equity Line of Credit (HELOC) at 4.9%. You could use a HELOC as a sort of second mortgage. There are two drawbacks to this:
- A HELOC typically give you a 10-year window to borrow, another 10-year window to pay off the loan, and a balloon payment at the end of 20 years to pay off any remaining balance. This means that you have 20 years rather than 30 to pay off this sort of second loan.
- A HELOC’s interest rate typically varies from month to month, so you may end up paying a lot more over time if the interest-rate environment worsens.
Alternatively, you could get a fixed second loan. Let’s assume this can be done at a rate that’s 2% higher than that of current first mortgages. Using our assumption above that your first loan has a 3.75% rate, the second loan would come in at 5.75%.
The difference between taking out a 90% LTV first loan at 3.75% vs. a first loan at 80% LTV plus a second loan at 10% LTV (leaving the remaining 10% to be covered by your down payment) is $27.32/month based on the above assumptions.
If you keep the home for at least 30 years and never pay more than the required payments, the difference adds up to $9835.20. That’s more than 61% lower than the $25,470 you’d pay for the PMI.
Importantly, if you sell your house sometime after the LTV drops below 80% (say after six years), you will have paid the full $25,470 for the PMI, but only $1967 in excess interest for the higher-interest second mortgage. This would save you more than 92% of the PMI’s cost!
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The Bottom Line: Structure Your Mortgage to Avoid Paying for PMI
If you buy a home in the US and pay less than 20% down payment, you’re required to pay for Private Mortgage Insurance, or PMI. This can cost you more than 5% of the total cost of buying your home, including the cost of taxes and insurance, and this is spread out over the few years your loan-to-value ratio is above 80%.
The PMI you’re paying for pays off your lender if you default in the mortgage and the foreclosure doesn’t cover the remaining mortgage balance. This protects your lender, but does nothing for you, because the PMI provider will turn around after paying off the lender and pursue you for what they paid the lender.
In my mind, that makes PMI legally sanctioned theft – you pay tens of thousands of dollars for something that brings you no benefit, and that you could avoid by structuring your mortgage in a smarter way at a fraction of the cost.
Frequently Asked Questions
What is private mortgage insurance (PMI)?
PMI is insurance you pay for, usually as part of your monthly mortgage payment, when you take out a mortgage for more than 80% of the home’s appraised value. If you default and the foreclosure sale leaves a remaining balance, the PMI provider pays the lender. The article notes the provider can then pursue you for what it paid, so the coverage protects the lender rather than you.
How much does PMI cost?
At the time the article was written, NerdWallet put PMI at 0.55% to 2.25% of the original loan amount per year. In the article’s example, PMI at the high end on a roughly $204,000 loan costs $383 a month and $25,470 in total before it can be removed.
When can you stop paying PMI?
According to the article, PMI continues until you owe less than 80% of the home’s value and request that it stop. In a stable real estate market, that happens slowly as you pay down principal; in the article’s example it takes about five and a half years.
How can you avoid PMI if you can’t put 20% down?
One approach the author used is to take out two mortgages: a first mortgage for 80% of the home’s value and a second loan to cover the gap between that and your down payment. Because no single loan exceeds 80% loan-to-value, PMI isn’t required. The second loan typically carries a higher rate (the article assumes about 1% to 2% higher), but in the author’s example it still costs far less than PMI.
Can you use a HELOC as a second mortgage to avoid PMI?
You can, but the article flags two drawbacks. A HELOC typically has a 10-year borrowing window and a 10-year repayment window, so you have 20 years rather than 30 to pay it off, and its rate usually varies, so you could pay much more if rates rise. A fixed-rate second loan avoids both issues.
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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.
About the author
Contributing Writer, Wealthtender
My career has taken some unexpected turns, from earning a PhD in experimental high-energy physics, to conducting cosmic-ray research in Antarctica, to supporting NASA projects and programs, to running my own consulting business. I also run several other small businesses and help my wife run her Marriage and Family Therapy practice.
Those experiences taught me to question assumptions, think critically, and recognize that real-world decisions of any significance rarely have simple answers that apply to everyone. Today, I bring that perspective to writing about personal finance. Drawing on my analytical background, business experience, and research, I explore financial decisions, challenge conventional wisdom, and help readers understand the tradeoffs that can affect their financial well-being. To complement my own research and experience, I also weave insights from financial professionals into my articles, drawing on their expertise and real-world experience helping clients navigate financial decisions and challenges.
At medium.com/@opher-ganel, you can read more of my articles and subscribe to receive email notifications when new ones come out.