Purchasing a property entails numerous requirements and stipulations. Unless you’re buying your first house with an FHA loan, most lenders require a down payment of at least 20%. Therefore, it makes it challenging for the middle and lower-class residents to afford homeownership. However, there are ways to circumvent the minimum down payment amount. Such as paying extra money each month, also known as “private mortgage insurance.” That way, the lender can protect itself from the borrower defaulting on their mortgage loan. In this article, we explain what is PMI and how it impacts borrowers looking to purchase property.
What is PMI?
PMI, “private mortgage insurance,” refers to a borrower paying less than the 20% down payment requirement. Therefore, the lender charges additional fees ranging .5% to 1.5% of the loan balance each year. In order to protect themselves in case the borrower defaults on a conventional loan and faces foreclosure. Private mortgage insurance paid monthly as part of the mortgage payment.
The rules for PMI vary depending on the type of conventional loan and the amount of the loan. Although paying additional money on a costly mortgage payment may seem overwhelming. However, accepting a loan with PMI might be the only way certain individuals can obtain a mortgage loan and homeownership.
How Much is PMI?
The exact amount a private mortgage insurance costs monthly varies depending on the type of loan, the amount of the loan, and the borrower’s overall credit score. On average, most lenders charge a PMI between .5% and 1.5% of the home’s appraised value. Therefore, to fully understand the terms of your loan and PMI, speak to the lender when you’re getting pre-approved to know your monthly payment, along with your buying power.
Cost Example for PMI: If a property’s value appraised at $200,000 and the borrower cannot come up with $40,000 for the down payment, the lender requires PMI. Furthermore, the PMI “private mortgage insurance” payment will cost between $1,000 and $3,000 extra on top of your mortgage payment yearly. View your payment letter, closing disclosure, or monthly statement for the exact number of your expected private mortgage insurance.
Factors that Influence Private Mortgage Insurance
There’s a wide variety of factors that play a role in your PMI, from financial aspects to overall credit score. Below are a few common factors that determine the PMI:
- The total loan amount. Since you’re paying a percentage of home value towards what is PMI, the larger the loan amount, the higher your private mortgage insurance payment will be.
- An overall credit score can reduce the PMI amount. Therefore, having a credit score of at least 700 can drastically lower your PMI amount, bringing it closer to the .5% of the loan amount.
How long do you pay a PMI?
A borrower pays private mortgage insurance until their loan’s paid to a value ratio below 80% of the home’s value or when the owner builds 22% equity. Therefore, to reduce the amount of time paying a PMI, consider paying ahead of schedule. However, one stipulation is that the homeowner must own the property for at least two years. It’s vital to note that making one extra payment on your mortgage in one calendar year applied towards the principal balance, reducing the time frame for your PMI.
Pros and Cons of What is PMI
Pros of Private Mortgage Insurance:
- Allows individuals to purchase a home without the required 20% down payment. When requiring less of a down payment, it helps individuals increase their buying power since less is required to close on the home.
- It’s not the full course of the loan. The PMI canceled once the loan-to-value (LTV) ratio reaches at least 78%.
- Reduces the lender’s risk. If the borrower defaults on their mortgage, a PMI protects the lender from potential financial losses.
- If your property value increases, you can refinance your mortgage to reduce or eliminate the PMI. However, keep in mind you’re responsible for closing costs if you decide to refinance.
Negative Aspects Associated with PMI:
- A portion of the monthly mortgage payment doesn’t get applied to your balance; it goes towards the private mortgage insurance. Therefore, it takes more time to lower the course of your loan. In addition to increasing your monthly costs, it is just an added expense.
- No tax benefits, PMI costs can’t be utilized as a tax deduction. On average, your mortgage interest payments deducted from your yearly taxes; however, that doesn’t apply to your private mortgage insurance.
- If the borrower defaults, they still face foreclosure and the consequences, such as an impact on their credit score.
- Being forced to pay the additional monthly fee for PMI until the borrower achieves 20% equity in their home, which can take several years.
Ways to avoid PMI
If you are currently looking to buy a home and would like to avoid paying PMI. The best way to do so is come up with a 20% down payment. A lender will not require private mortgage insurance if the borrower produces the standard down payment. There are a few ways to avoid it. You can ask your lender if there is any down payment assistance you can apply for through PHFA, such as HOMEstead, and Keystone Advantage Assistance. They will give you money towards your down payment.
You can also talk with your realtor about requesting sellers assist. Sometimes, if a home has been sitting for a little while, or the owner is motivated to sell. You can factor in a certain amount in your offer. Example: The asking price is $200,000, and you offer $210,000 with 10k in sellers asssit. You will get back $10,000 at settlement to use towards closing costs. The owner still gets their asking. It can be a win-win situation that helps you avoid paying private mortgage insurance.
What is PMI: Is it Worth Paying?
Although it may seem undesirable to pay additional monthly fees to own a home. At times, it’s difficult to come up with a down payment of 20% and there’s no other option if we desire homeownership. Therefore, a mortgage lender will require the private mortgage insurance to protect themselves if the borrower defaults on the loan. The PMI varies based on factors such as the loan amount or the borrower’s credit score. Therefore, it’s suggested to achieve a credit score of at least 700.
Additionally, it’s vital to understand the terms of your PMI and the amount of your monthly payment. Therefore, the borrower can determine their budget and figure out if homeownership can come in the near future. If you happen to fall behind on your monthly payments, contact the loan servicer right away to explore options such as loan modification to avoid foreclosure. Additionally, if your property has drastically increased in value, consider getting a home appraisal showing sufficient equity of 20% or more, which can cancel the PMI. After reading this article on what is PMI, if you still have questions, feel free to contact me for advice or guidance from a real estate professional.
FAQ about PMI
Buying a home can seem challenging at times. Almost like you need to be guided in the right direction, plenty of people will have tons of frequently asked questions about PMI:
- Is PMI Tax-Deductible? No, it is not a tax deduction. But the intrest payments on your mortgage are. With mortgages, we tend to pay a lot in insurance. Especially if you are currently paying PMI.
- Does a PMI protect me from foreclosure? No, it does not, as we mentioned in the article. A PMI is a private mortgage insurance. It only protects the lender from the borrower.
- Do all lenders request PMI? Yes, all mortgage lenders will request private mortgage insurance. It is a way to protect the lender. If you can’t save up enough for 20% down. The lender will take it as a red flag.