Private mortgage insurance (PMI)

Private mortgage insurance is an insurance product that protects the lender when a borrower puts less than 20% down on a conventional loan. The insurance covers some of the lender's loss in case of foreclosure. The borrower pays the premium; the lender receives the protection.

How it works: PMI is typically charged as a monthly amount, calculated as the loan amount times an annual rate (usually 0.32% to 0.85% depending on loan-to-value ratio and credit profile), divided by 12. On a $400,000 loan, that's $1,300–$3,400 per year, paid as part of the regular mortgage payment.

Why it matters: PMI is not free, and over the years it stays on the loan, it adds materially to the cost of homeownership. The Homeowners Protection Act of 1998 requires lenders to cancel PMI automatically when the loan-to-value ratio reaches 78% on the original amortization schedule. Borrowers can also request cancellation earlier, at 80% LTV (with a written request) or based on appreciated home value (typically requiring an appraisal).

Common gotcha: FHA loans don't have PMI, they have mortgage insurance premium (MIP), which works differently. MIP doesn't auto-cancel for FHA loans with less than 10% down; it stays for the life of the loan. This is one of the major differences between FHA and conventional financing, and it's the main reason many FHA borrowers eventually refinance to conventional.