Purchasing a home comes with a few additional costs that may not be entirely clear. Realtor fees, closing costs, and home insurance are just a few of the things that can slowly drive up the cost of being a homeowner.
Another is private mortgage insurance, also known as “PMI.” This fee is added to many mortgage loan, especially ones that have less than 20% as a down payment. While the monthly cost of PMI is small compared to the total mortgage, it can still add to your bill. If you plan on purchasing a house, no matter what down payment you might bring, it helps to fully understand the reasons for PMI.
Private Mortgage Insurance: The What, How, and Why of PMI
What is Private Mortgage Insurance?
PMI is an added fee that goes with many mortgage loans. Essentially, it an an insurance payment on your mortgage that helps cover the lender against a default on the loan. If you can’t pay your mortgage, the company or organization providing mortgage insurance compensates the lender.
Although you pay for PMI, the purpose is to protect the lender. By paying for the insurance, you reduce the risk to lenders and, therefore, make them more willing to write a loan on your home purchase. Without PMI, borrowers would either pay higher amounts in interest rates or the loans would be entirely unavailable.
Mortgage insurance can be added to a wide range of loan products. Typically, it is added to conventional loans that have less than 20% equity by the borrower. In this case, the loan will arranged with an insurance company that provides the PMI support.
FHA loans will also have FHA mortgage insurance. In this case, the cost of the insurance is the same for all borrowers, and it will likely be an upfront and monthly cost. USDA loans and VA loans will also have mortgage insurance tacked onto the costs. For these programs, the insurance is technically not private mortgage insurance, but the result, as far as you’re concerned, is the same: you pay an added fee to insure the loan against default.
The cost of a PMI comes in the form of a monthly insurance premium, although the payment is usually rolled into the monthly mortgage payment. There may be an upfront cost, depending on the lender and the type of loan you get.
How Much is PMI?
Like all things in mortgage lending and real estate, the total price depends on many factors. However, borrowers can reasonably expect their PMI to cost about .3 to 1.15% of the home loan amount, according to Realtor.com. The actual dollar amount will depend on the loan total, your credit score, and the equity you have in the home, but Fannie Mae says that most people will pay between $30 and $70 a month for mortgage insurance.
Can PMI Be Avoided?
Yes, PMI can certainly be avoided. Although specifics vary, the golden number for PMI is 20%. If you have 20% equity in the home, you will not need to pay PMI, because the chances of default, statistically speaking, have been lowered once you reach this threshold. 20% equity can be reached in a couple different ways.
First, you can simply provide a 20% down payment. Obviously, this is a significant amount; for example, if you are purchasing a $500,000 home, a 20% down payment would be $100,000. That’s not an amount most people have sitting around.
The other way to reach 20% is through your regular payments. As you pay off the loan, your total ownership in the property increases, driven in large part by a process called amortization. Once the loan is paid, you own 100% of the property. At some point during the loan payments, you will pass the 20% mark. Once you reach this milestone, the PMI disappears for most loans. (This is dependent on the lender. Some loans, for whatever reasons, may have permanent PMI; others may have PMI until 18%, 22%, 25%, or any other number determined by the lender.)
Ways to Lower PMI
Avoiding the added PMI payment would be great, but what if you have no option but to move forward with the insurance payment. In this case, there are a few ways to lower your payments. The point of mortgage insurance is to protect the lenders against default, so if you can show that you are less of a risk, you may be able to get a lower premium.
Having good or excellent credit, for example, shows that you are a reliable borrower who understands how to deal with debt payments on a consistent basis. With a higher credit score, you may be able to have a lower insurance premium. If your credit is low, you can try to improve your score before seeking the loan. By lowering your score, you could also get a better interest rate, which means lower mortgage payments as well. Lowering the amount borrowed by purchasing a smaller or less-expensive home could also reduce PMI payments.
When Does PMI End?
Again, this will depend on the lender, the loan products, and your equity in the property, but in general, once you reach the 20% mark (or whatever mark set by the lender), you will no longer have to pay for PMI. Essentially, once you reach this mark your mortgage payment will be reduced by $30 to $70, depending on the insurance premium totals.
The Argument for PMI
Private mortgage insurance seems like something to be avoided, but if you look at the added benefits, you can see a few positives. Essentially, PMI allows borrowers who may not qualify for a loan to purchase the house they want. Instead of saving money for a down payment while missing out on years of ownership, you can purchase a home, albeit with a higher payment, and start gaining equity. PMI could make financial sense when you consider the potential loss from not owning a home.
Helping You Make the Right Choice on Private Mortgage Insurance
Determining whether or not a loan with PMI makes financial sense is a personal decision, but it never hurts to have sound advice from a knowledgeable professional.
We’ll make sure you have the right information to make a smart decision for your homeownership goals.