Why PMI?

Private Mortgage Insurance: Is it Right for You?

By SaleCore

As a homebuyer ready to take the plunge, a mortgage lender will typically require a minimum down payment of 20% of the home's purchase price. As a borrower, if you cannot meet that minimum requirement, a lender will view the loan as a risky investment and therefore require Private Mortgage Insurance, also known as PMI. What does this mean for you? While PMI does have some downfalls, it may have its advantages as well. It is important to do your research, get all your questions answered, and make the best decision for you and your situation.

1. What is PMI?

Private mortgage insurance paper form on desk

When you are unable to put down at least 20%, PMI is an additional monthly fee rolled into your mortgage payment. It is especially common for government-backed loans, such as FHA and USDA mortgages, popular among first-time homebuyers. PMI is not to be confused with homeowner’s insurance, as it protects the lender, not you, if you default on your loan.

Your lender will coordinate with a private insurance provider, and the terms of the insurance plan will be provided to you before you close on your mortgage.

2. Is it Possible to Avoid PMI?

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As a rule, most lenders will require PMI for mortgages with a down payment of less than 20%. However, there are some exceptions, so be sure to research your options if you want to avoid PMI.

  • If it applies, take advantage of first-time homebuyer programs that vary by state, territory, county, and city. These programs help first-time buyers with down payment assistance and closing costs, that in-turn can help them avoid paying PMI.
  • Consider applying for a government-insured loan. While conventional loans are most common in home financing, it’s just one of many options. Look at FHA, VA, and other types of home loans to make sure you’re getting the right one for your situation.
  • In some cases, lenders will waive PMI for borrowers with less than 20% down, but in-turn will increase your interest rate, so do the math to determine if this kind of loan makes sense for you.
  • Some credit unions or lending institutions may not insist on PMI for individual applicants. For example, they may waive the PMI requirement if the borrower transfers all savings and checking accounts to the lender’s institution. A lender may also waive PMI if the borrower has a stellar credit profile.
  • Opt for an 80-20 “Piggyback” loan. 80-20 mortgage is paid through two loans, a first and a second mortgage. The “80” first mortgage covers the loan; the “20” second mortgage is the down payment, and usually carries a higher interest rate, in which the interest can be deducted on your tax return.
  • In some situations, "owner financing" works like rent-to-own, in which case you probably wouldn’t be required to pay 20% down or PMI.
  • Shop homes at a lower price point, as the difference in down payment for lower-priced homes may fit your savings account better, and you can trade up at a later time.

3. How Much Will You Pay in PMI?

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Your down payment is the most significant factor in determining how much PMI you’ll pay. As expected, your PMI payment will be higher if your down payment is lower. If, however, you’ve built a strong credit history showing financial responsibility, you may qualify for a lower premium. Homebuyers typically pay about 0.5% annually of the total amount borrowed, with the cost split across 12 months. While the amount varies, you can expect to pay between approximately $30 and $70 per month for every $100,000 borrowed.

4. How Long Do I Have to Pay PMI?

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PMI is a means to an end, and therefore may only be temporary. How long you actually have to pay it will be dependent upon the loan type.

  • With a conventional loan, it is possible that once you've built 20% of the loan’s principal amount in equity, by either paying down the balance or through rising home values, you can cancel your PMI and remove that expense from your monthly payment.
  • With an FHA loan, however, PMI continues for the life of the loan or until refinanced.

5. What are the Benefits to Paying PMI?

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Although PMI is in place to protect the lender and an added expense for you as the borrower, it doesn’t mean there aren’t some advantages.

  • If your credit score is high and your Loan-to-Value (LTV) is relatively low, you should be able to get a low PMI rate, which will make your mortgage more affordable overall.
  • Paying PMI may be the only way you are able to purchase a home, and can even help you build wealth faster as you begin to build equity immediately.

Talk with your lender about what makes the most sense for your financial situation. Remember, you have options, and don’t agree to a mortgage without comparing offers from at least three different lenders to ensure that you are getting the best rates and terms.

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