Homeowners in California have several ways to convert their home equity into cash. One common…
Estimating the Average Cost of Private Mortgage Insurance (PMI) in California
Private mortgage insurance (PMI) is often required when a home buyer makes a down payment below 20%, resulting in a loan-to-value (LTV) ratio above 80%.
In California, the average annual cost of PMI usually ranges from 0.58% to 1.86% of the mortgage loan amount. To determine the typical monthly cost, you would multiply the loan amount by the above percentages and divide by 12.
Private mortgage insurance increases the size of the monthly housing payments. So you’ll need to factor it into your budgeting process.
But it offers some important benefits as well. PMI allows California home buyers to make a purchase sooner rather than later, by reducing the down payment amount that’s required.
What Is Private Mortgage Insurance (PMI)?
Private mortgage insurance (PMI) is a type of insurance that lenders require borrowers to pay when they make a down payment of less than 20% on a home purchase. Specifically, it’s usually required when the loan-to-value ratio rises above 80%.
PMI protects the lender in case the borrower defaults on the loan. It gets added onto the monthly mortgage payment, increasing the size of those payments. But it can also help borrowers qualify for a loan they might not otherwise be able to get.
Once the borrower’s equity in the home reaches 20%, PMI can be canceled.
Private mortgage insurance allows California home buyers to obtain mortgage financing with a lower down payment. This means that buyers can purchase a home sooner rather than later, since they don’t have to save up as much money for a down payment.
Traditionally, lenders have required a 20% down payment as a way to mitigate their risk. But saving up that much money can be challenging, particularly for first-time buyers in California. PMI bridges this gap by enabling borrowers to buy a home with a down payment as low as 3% of the purchase price.
Average Cost of PMI in California
The annual premium amount for a California PMI policy is typically expressed as a percentage of the loan amount. According to data from the Urban Institute’s Housing Finance Policy Center, the average cost ranges from 0.58% to 1.86% of the loan amount, per year.
A PMI Example Using Actual Numbers
The following scenario will help you understand how the average PMI percentages described earlier could affect a homeowner’s monthly payments.
The median home price in California is currently around $790,000. So let’s assume a home buyer uses a conventional loan to buy a house in that price range, with a down payment of 5%.
Here’s how the annual cost of mortgage insurance would work out on a monthly basis:
- Home purchase price: $790,000
- 5% down payment: $39,500
- Base loan amount: $750,500
- Annual PMI rate range: 0.58% to 1.86%
- Annual PMI cost: $4,353 to $13,959
- Monthly PMI cost: $363 to $1,163
Your mortgage insurance costs will vary based on the amount you borrow, the size of your down payment, your credit score, and other factors. But the same basic calculation will apply.
Fortunately, you don’t have to worry about doing the math. When you apply for a mortgage loan or get pre-approved, your lender will give you an estimate of all loan-related costs, including PMI.
Factors That Can Determine How Much You Pay
Like other types of consumer insurance, PMI costs are heavily influenced by risk. Insurers use a variety of risk-assessment measurements when setting the annual premium rate.
Here are five factors that can determine PMI costs:
1. Your credit score
In most cases, a higher credit score can result in lower PMI costs.
That’s because credit scores are largely influenced by the way a person has borrowed and repaid money in the past.
A person with a higher score is considered to be a lower risk for the lender, so they often qualify for lower mortgage insurance rates. On the other hand, a home buyer with a lower score might end up paying more in overall PMI costs.
Having good credit could also help you qualify for a mortgage loan in the first place, while securing a favorable interest rate in the process.
2. Your down payment amount
You could avoid PMI entirely by making a down payment of 20% or more, or by using the so-called piggyback mortgage strategy.
But once you get below the 20% threshold (where mortgage insurance is typically required), the monthly cost can vary based on the amount you put down. Generally speaking, a larger down payment will result in a lower PMI rate because it reduces the lender’s risk.
3. The type of home loan you choose
California home buyers have a lot of options when it comes to the type of loan they choose. And these choices can also affect the amount you pay in private mortgage insurance.
For example, adjustable-rate mortgage (ARM) loans sometimes have higher PMI costs when compared to the more popular fixed-rate option. ARM loans carry a higher level of risk due to the possibility of fluctuating interest rates.
Strategies for Reducing Your Costs
We’ve talked about the typical cost of private mortgage insurance in California, as well as the main factors that can influence those costs. This information also provides a roadmap for reducing your overall PMI costs.
The following strategies could help you pay less in mortgage insurance over the long term:
1. Increase your down payment amount.
Home buyers in California could lower their mortgage insurance costs by putting more money down up front. Making a bigger down payment reduces the loan-to-value ratio (LTV) and the overall risk level.
Even a small increase in the down payment could have a noticeable impact on your PMI rate.
Of course, not everyone can afford to do this. Some home buyers can only afford the absolute minimum down payment for a mortgage loan, which usually falls within the 3% – 3.5%.
But if you can afford to put more money down, it’s worth considering. It could help you secure a lower mortgage rate as well as reduced mortgage insurance premiums.
2. Improve your credit score.
Earlier, we talked about the credit score being one of the primary factors that influences a home buyer’s PMI costs. Credit scores are a kind of risk indicator, and mortgage insurance prices are heavily influenced by risk.
A higher credit score could help you qualify for a lower PMI rate, reducing your monthly payments and potentially saving you a lot of money over the long term.
According to the credit reporting bureau Experian: “There are several ways you can improve your credit score, including making on-time payments, paying down balances, avoiding unnecessary debt and more.”
3. Shop around for PMI.
As with other forms of insurance, the cost of PMI in California can vary from one provider to the next. So it pays to shop around for the best rate.
Remember those price-influencing, risk-related factors from earlier? Well, different insurers use different methods for analyzing those factors and setting their mortgage insurance rates.
4. Consider piggyback loans as an alternative to PMI.
Even if you can’t afford to put 20% down on a home purchase, there are ways to avoid the additional cost of PMI. The piggyback strategy could help you achieve this goal.
With this approach, the borrower combines two mortgage loans and makes a relatively small down payment to cover the rest of the purchase price. The 80-15-5 piggyback strategy is a common example. It works like this:
- 80%: The first mortgage covers 80% of the purchase price.
- 15%: A second mortgage covers 15% of the purchase price.
- 5%: The buyer makes a down payment of 5%.
By dividing the mortgage portion into two parts, home buyers can keep the individual loan-to-value ratios below 80% and thereby avoid PMI.
Seven Things to Take Away From This Guide
We’ve covered a lot of important information here. So let’s wrap up with a quick summary. Here are seven key points you should take away from all of this:
- Private Mortgage Insurance (PMI) is usually required when the down payment is less than 20% of the home purchase price.
- PMI protects the lender if the borrower defaults on the loan, thereby reducing their risk.
- It also benefits home buyers by allowing them to make a smaller down payment, reducing their upfront out-of-pocket expense.
- The average annual cost of PMI in California ranges from 0.58% to 1.86% of the loan amount.
- Several factors can influence the cost of PMI, including the credit score, down payment amount, and type of home loan.
- Strategies to reduce PMI costs include increasing your down payment, improving your credit score, and shopping around for the best rates.
- Bridgepoint Funding can help you explore your mortgage options to find the best loan for your particular situation!
Disclaimer: This article explains the average cost of private mortgage insurance in California by using current home prices and typical down payment amounts. There are many variables that can determine the actual costs associated with a home loan. Because of this, portions of this article might not apply to your particular situation.
