Close Look at Private Mortgage Insurance (PMI)

Purchasing a home can be very troublesome. This process requires you to understand the relationship between down payments and private mortgage insurance. You may need to for pay an extra insurance on your loan if you make a down payment below 20%. Moreover, private mortgage insurance is an excess cost that increases the size of your monthly payments.

Mortgage insurance is different from other insurance plans. You pay a monthly premium to the insurer who protects the mortgage lender in your absence. In this article, you will learn more about PMI, how much it might cost, and what you can do to avoid it.

What is Private Mortgage Insurance?

You will have to pay for PMI if you a deposit of less than 20% when using a mortgage loan. Mortgage insurance secures the lender in the circumstance that default on your loan. This means that for some reason you are not making your mortgage payments. Furthermore, any home loan that considers for more than 80% of the purchase price should require a PMI. Lenders carry a risk when they make a large investment in a home. Therefore, they charge an extra insurance to offset this additional risk.

For example, PMI will probably cover 15% if you put down 5% to purchase a home. A loan default triggers both the policy payout and foreclosure proceedings. This allows the lander to repossess the home and sell it in an attempt to regain the balance of the debt.

Cost of Private Mortgage Insurance

The cost of PMI depends on the size of the loan and the insurance company being used. You can expect to pay anywhere from 0.5% to 1% of the loan annually. This comes out to $50-$80 per month on a $160,000 home ($600-$960 per year). For a $200,000 home, the cost of the PMI may be $125 per month or more. The greater the loan, the higher the cost of private mortgage insurance.

Cost of Private Mortgage Insurance

The cost of PMI depends on the size of the loan and the insurance company being used. You can expect to pay anywhere from 0.5% to 1% of the loan annually. This comes out to $50-$80 per month on a $160,000 home ($600-$960 per year). For a $200,000 home, the cost of the PMI may be $125 per month or more. The greater the loan, the higher the cost of private mortgage insurance.

Avoiding Extra Cost of PMI

Avoiding extra PMI costs is possible when your down payment is less than 20%. Previously, I mentioned that you need PMI when a loan accounts for more than 80% of the home’s purchase price. However, you can avoid PMI if neither one of your two mortgages accounts for more than 80%. This is called the piggyback strategy. You have another mortgage loan that piggybacks on the first.

An example of this tactic is the 80-10-10 financing method. You receive the first mortgage loan for 80% of the purchase price and the second one for 10%. Additionally, you would have to deposit the remaining 10% in the form of a down payment. You can do the math and see that the total amount equals 100% of the purchase price. Nevertheless, neither of these two loans accounts for more than 80% of the purchase price. Therefore, you are likely avoid the extra cost of PMI when using this strategy.

Another example is the 80-15-5 mortgage. Same concept, however his time the borrower is making a down payment of 5%. The first and second mortgage loans consider for 80% and 15% of the purchase price. Again, there is no single loan covering greater than 80% of the purchase price.

Cancelling PMI

You are able to cancel your PMI once your mortgage principal balance is less than 80% of the current market value of your home. Usually, there are additional restrictions like a history of timely payments and the absence of a second mortgage. Mortgage lenders are responsible for telling you long it will take for you to reach that loan-to-value mark and update you of any cancellation options annually. They also cancel your PMI once the mortgage balance drops below 78% of the original value. Likewise, PMI can be terminated if you reach the midpoint of your payoff.

Factors to consider when selecting a loan that requires PMI

Similar to other types of mortgage insurance, PMI allows you to qualify for a loan that you may not be able to obtain. However, this also increases the cost of your loan. Thus, you are not protected if you run into problems with your mortgage. Only the lender is safe.   

Lenders often give conventional loans with smaller down payments that do not depend upon PMI. You will usually pay a greater interest rate for these loans. Furthermore, paying a greater interest rate can be either more or less expensive than PMI. This depends on a variety of factors such as the time period you plan to stay in the home. You have the option to ask a tax adviser about whether paying more in interest or PMI affects your taxes differently.

Borrowers who make a down payment may choose to consider other kinds of loans like the FHA loan. The cost of other kinds of loans can be more or less expensive than a conventional loan with PMI. This price depends on your credit score, down payment amount, the particular lender, and general market conditions.

Another alternative you have is saving up the money to make a down payment of 20 percent. PMI is not necessary with a conventional loan when you pay 20 percent down. Nonetheless, you receive a lower interest rate with this down payment.    

Therefore, ask lenders to show you the pricing for different options so you can see which one is the best deal.