What is PMI?
Private mortgage insurance (PMI) is an often-overlooked cost that homeowners may need to pay when buying a home with a conventional mortgage or refinancing that loan. Understanding PMI can help you to avoid paying it or saving money in the long term. Here’s what you need to know:
What is PMI?
PMI is a fee that you are usually required to pay if you have a conventional mortgage loan and you are unable to put 20% down. You may also need to pay it if you refinance and your equity is less than 20% of the value of your home. PMI protects the lender if you stop making payments on your loan. However, it doesn’t protect you, and you are still at risk of foreclosure if you can’t make your payments.
How Much Does PMI Cost Me?
PMI can have an annual cost ranging from 0.25% to 2% of the mortgage loan balance, depending upon the size of your down payment, the amount of your loan, the loan term, and your credit score. For example, let’s say that you had a 1% PMI fee on a $200,000 loan. That fee would add approximately $2,000 a year/$167 a month to the cost of your mortgage. Unlike paying your mortgage principal, which goes toward building equity or mortgage interest, which is tax-deductible, PMI is simply a fee that doesn’t provide a return on investment for you.
How Do I Pay for PMI?
While there are several ways to pay your PMI, the most common method is a monthly premium added to your mortgage payment. Some lenders will offer other payment options, including one upfront premium at closing, or paying a portion of that premium at closing and the rest monthly. Review your loan estimate and closing disclosure to get an accurate breakdown of what you’re being charged for PMI.
How Do I Avoid PMI?
The easiest way to avoid PMI is to have a 20% down payment. If that isn’t possible, there may be other types of loans available that don’t require PMI. Some lenders will offer loans with smaller down payments and no PMI, but they are also
likely to have a higher interest rate. Whether this type of loan makes sense for you will depend on factors including how long you plan to stay in your home. Because mortgage interest is tax-deductible, talk to your tax advisor when trying to determine
which option is right for you.
Other options such as Federal Housing Authority (FHA) loans allow you to avoid PMI while paying less in interest and less upfront. These savings are made possible because the federal government helps guarantee the loans, reducing the risk to the lender. These loans will be dependent on factors, including your credit score, the lender, and market conditions.
Even if you don’t request it, your lender is required to drop the PMI when your balance equals 78% of your home’s original purchase price.
Can I Speed Up the Process?
The good news about PMI is that it doesn’t last forever. The key is to build up 20% equity in your home. How long this takes will depend on your mortgage. However, you can get out of PMI sooner. The trick is to reach the 80% equity level as quickly
as possible. There are a few ways to do that:
- Paying Down Your Mortgage Faster
By paying a little bit extra toward your monthly mortgage payment, you can lower your principal, which in turn lowers the amount you need to pay in interest.
You can get your home reappraised, and if your home value has increased to the point where your balance equals 80% or less of the home’s new value, you can request the lender to cancel the PMI. The reappraisal will cost between $300 and $600, so make sure your home has gained value before you spend the money.
Thinking of refinancing your mortgage? If you do, and the balance of your new mortgage is less than 80% of the home’s current value, you may be able to avoid PMI.
The Tradeoffs and PMI
PMI is an added monthly expense that you can avoid if you save enough to put 20% or more down for a mortgage. While waiting to save that amount can seem tedious, there are additional advantages. If you continue to rent, you won’t be paying insurance, property taxes, or maintenance fees. If you settle for a less expensive home, you’ll save on PMI and a larger mortgage payment.
How Can I Get Help With PMI?
Sometimes, PMI is the only way for a new homebuyer to make their first home purchase. If you have questions about PMI, talk to your mortgage lender or financial institution. They may be able to offer loan options that allow you to avoid PMI, or if you’re currently paying for PMI, they may be able to help you avoid paying it in the future. For information about mortgages at American Heritage, click here.