Saving enough money for a hefty down payment may be keeping many Americans from owning a home. But private mortgage insurance (PMI) can help you get a loan you wouldn’t conventionally qualify for.
Costing more than your mortgage payment, homeowners insurance, and other bills tied to homeownership, PMI is used more often than you think: $270 billion in insurance coverage was provided by private mortgage insurers in new mortgages in 2016 alone, according to the Housing Finance Policy Center.
But what is private mortgage insurance, how much does it cost, and how does it work? Here’s an overview of the critical factors related to PMI and how to use it to buy your new home.
What is Private Mortgage Insurance?
Most lenders require homebuyers to put down about 20 percent of their home’s purchase price to qualify for a conventional (non-government) loan. This can be a big commitment for consumers, especially first-time buyers who are consistently saving each month but are still struggling to accumulate those savings. According to the National Association of Realtors, sixty-one percent of first-time buyers made a down payment of 6 percent or less.
This is where the PMI comes into play. If buyers can’t afford the 20 percent or need to divert some of their savings for other homeownership expenses, lenders can still provide them with a conventional loan as long as they have PMI.
PMI allows borrowers to qualify for a conventional loan even if they put down 5 percent or up to 19.99 percent. It is usually arranged by the lender and issued by private insurance companies. PMI is classified as “private” to distinguish it from government-backed loans and insurance.
To be clear, while you pay for insurance, the coverage is not for you. It serves to reduce the risk of a loan for lenders. If you can’t give 20 percent, lenders may view you as a high-risk client. PMI is to protect lenders in the event of a default on your loan.
How Much Does Private Mortgage Insurance Cost?
PMI costs vary, depending on various factors, including your down payment, mortgage size, loan-to-value ratio, and credit rating.
Most lender websites state that it will range from 0.25 percent to 2.25 percent of your outstanding loan balance each year, so the more significant your mortgage, the higher your PMI premiums.
Other factors include whether your interest rate is fixed or adjustable, how large your mortgage is, whether it’s your first home, second home, or a real estate investment, and the amount of coverage your lender needs. As always, when it comes to securing loans, the riskier what lenders perceive, the higher the premiums you’ll have to pay. A buyer with an excellent credit score paying 15 percent on a 10-year fixed-rate mortgage will get lower PMI premiums than their counterpart who is paying 5 percent on a 30-year adjustable-rate mortgage. Years, for example.
There are six PMI companies in the United States, and they generally charge similar rates. If your lender decides that you will need to pay PMI, it will be arranged through one of these insurance providers. Before your loan closes, you’ll know exactly how much you have to pay in PMI costs and for how long.
The PMI is not cheap. If you have a $200,000 mortgage, your PMI could cost you between $1,100 and $4,500 a year, or about $92 to $375 each month. According to Freddie Mac, you can expect to pay between $30 and $70 per month for every $100,000 borrowed. This PMI expense is in addition to your monthly mortgage payments, property taxes, and other maintenance fees.
If you’re competing for a lower PMI rate, there are a few things you can do. For starters, keep your credit score in tip-top shape and stay on top of all your payment due dates. Choose a house that is not as expensive so that it has a smaller mortgage and a lower loan-to-value ratio, and pay as much as you can towards your down payment so that it is as close to 20 percent as possible.
How do Private Mortgage Insurance Payments Work?
PMI payment options vary by lender; some offer payment options while others have a fixed policy.
For the most part, consumers pay their PMI payments in two ways: as a lump sum payment each year, known as lump-sum mortgage insurance, or as an expense accrued into their monthly mortgage payments, known as customer-paid mortgage insurance Borrower.
With single-premium mortgage insurance, your mortgage insurance is paid for all at once when your loan is closed. Because you’re paying upfront, your monthly mortgage payment will be lower overall. However, it can be challenging to deliver. If you have little money, it may not be feasible to pay a lump sum for the following year. The other downside is that if you decide to refinance or sell your home, the lump sum payment is non-refundable.
Borrower-paid mortgage insurance is included in your monthly mortgage payments, making the expense more affordable.
Finally, a third option combines both options: You make a partial down payment and pay the rest on your monthly mortgage bill.
If your lender decides you need to pay PMI to qualify for your loan, talk to them about your repayment options.
Your lender can provide you with a cost breakdown for each option to help you decide which is most feasible and cost-effective for your circumstances. Your loan documentation should outline PMI premiums and projected payments, so you know exactly what you’re getting into.
When Do I Stop Making PMI Payments?
As a general rule, your PMI premiums generally end once you have more than 20 percent equity in your home or when you’ve built up enough equity that your lender no longer considers it high risk. This could take years, depending on how high your mortgage payments are and how much money you’re funneling into building equity in your home. Reports suggest that the magic number is 11 years, on average.
You can take the initiative and request to suspend your mortgage insurance payments once your loan-to-value ratio falls below 80 percent. When you apply to complete your PMI, make sure you have a solid mortgage payment history and that you have no liens on your home. In some cases, lenders may request an updated home appraisal to get a current view of your home’s value.
However, once your loan-to-value ratio reaches 78 percent, your lender automatically cancels your PMI under the Homeowner Protection Act.
Another option is to check the value of your home. If you have built up more equity in your home due to appreciation, your PMI could also be canceled. I’d have to test this, again, through an evaluation.
What Happens If I Don’t Want To Pay For Private Mortgage Insurance?
You have some wiggle room if you decide that PMI is an added expense you don’t care about. As we described above, you can avoid this altogether by paying 20 percent upfront and committing to a less expensive home and, in turn, a smaller mortgage.
You can also consider other low-down-payment loans that don’t require PMI. What do you eat with this? Slightly higher interest rates on your mortgage. For example, Quicken Loans’ PMI Advantage eliminates the need for PMI for mortgages with less than 20 percent down, but you’ll pay the difference with a higher interest rate.
Bank of America offers affordable loans for new and “modest income” homebuyers. With this program, buyers can obtain mortgages with as little as 3% down and no PMI. However, Bank of America noted some caveats: buyer education may be necessary, especially for first-time buyers; loan limits may apply depending on location, and PMI may be an option but at a reduced cost compared to conventional loans.
Finally, government-backed loans like Veteran Affairs home loans are worth considering if you qualify. This department offers VA home loans to help veterans buy, build, or improve a home or refinance current home loans. Because the government backs them, nearly 90 percent of all VA loans are made without a down payment and generally do not require mortgage insurance.
Federal Housing Administration loans require mortgage insurance but are worth considering because rates can be lower than PMI.
Is Private Mortgage Insurance Worth It?
The answer depends on the individual. Yes, PMI is another expense to consider, but it can help you through the process of becoming a homeowner, so you don’t have to wait until you’ve accumulated 20 percent. If you have an excellent credit score and your loan is not substantial, you may be able to get a lower PMI rate.
You’ll need to do some math to assess how much you’ll spend each year on PMI, property taxes, and interest on your mortgage. If your home’s value appreciates quickly, those expenses may be worth it: Rising home prices are the number one reason consumers put their savings into bricks and mortar.
On the other hand, you could continue renting and saving for future ownership. But it’s better to act early because home prices could continue to rise.
Don’t forget personal and other factors that affect mortgages. For some people, homeownership is a crucial milestone they want to reach at a certain age, while for others, stability is essential for a young family so that PMI may be worthwhile. Choosing to eliminate PMI requires careful consideration, but it’s a great tool if you decide it’s your ticket to a mortgage.
