What is Private Mortgage Insurance (PMI) and how does it affect your mortgage payments?
There are a lot of terms thrown around when you buy a home: homeowners insurance, closing, title search, interest rates. It can be a confusing and overwhelming time, and if you've never heard of something before, it can be difficult to know what it is and whether it's a must-have or something you can skip.
Private mortgage insurance, sort for PMI, is one of those things. Not everyone has to have it, and it does make a difference to your financial bottom line when it comes to your mortgage.
What is Private Mortgage Insurance (PMI)
Most people, when they buy a home, put down a down payment. Typically, this is about 20% of the home's purchase price. In some cases, however, a buyer doesn't have a 20% down payment, but they are otherwise well-qualified for a loan.
Private mortgage insurance is a product that allows this kind of buyer to still move forward with their home purchase. It's a special kind of insurance that protects the lender - not the buyer - against loss. If you default on the loan, private mortgage insurance ensures the lender doesn't face a total loss.
Private mortgage insurance can be canceled once you have 20% equity in your home (meaning you have paid 20% of the loan's principal). The timing of when this happens can vary depending on many factors, but you'll usually get some paperwork at closing that will give you an estimate of when you can expect this.
How is it applied and how does it affect my mortgage payments?
There are three kinds of PMI. There is Borrower-paid, Single premium, and Lender-paid.
Borrower-paid PMI is exactly what it says. This is PMI that you pay for. You'll pay a premium every month, either rolled into your mortgage payment or separately, until you've reached the point in your loan at which you can cancel the PMI. Once you've paid 20% of the loan's principal, as long as your home's value hasn't dropped, you're current with your payments, and you don't have a second mortgage or subordinate lien on the home, you can ask the lender to cancel your PMI and they should comply.
Single premium PMI is when you pay your PMI premium in a single, upfront lump sum. This eliminates the need for monthly payments. It can be paid at closing or rolled into the mortgage payments, so it may or may not keep your mortgage payments from increasing. It requires more money upfront, but can save you money in the long-term.
Lender-paid PMI is when your lender pays the PMI on your behalf. This will keep your mortgage payments lower, but the interest on this kind of PMI tends to be higher, so you may still pay more over the life of your loan to have this kind of PMI. Additionally, this kind of PMI cannot be canceled, as it's a permanent part of the loan.
Tips on how to avoid or pay down PMI fast to save more for homebuyers
PMI isn't cheap. Typically it's 0.1% of the mortgage principal. If it's possible, you want to try to avoid it. There are a few ways you can try to avoid it.
Buy a smaller, more affordable home: If you've started saving for your down payment, but you don't have quite enough, look around for a less expensive home for which your down payment might meet the 20% threshold.
Save more money before you buy: The urge to buy is strong, especially when you find a home you fall in love with. But if you don't have enough money for the down payment, it might be worth waiting a bit longer until you do have the money.
Take out a second mortgage to make up the lack of down payment money: Sometimes called a piggyback loan, what you do here is take out your main mortgage for 80% of the home's value (this eliminates the need for PMI). Then, you take out a second loan for the amount you need to make up the difference between your down payment, first mortgage, and what you need. So, if your buying a home worth $100,000, your first mortgage would be for $80,000. You'd have $10,000 for your down payment, so your piggyback loan would be for $10,000. The catch to this kind of loan is that typically, you'll pay a higher interest rate on this kind of loan, so it may still cost you more money overall.
PMI is avoidable, and if you can, you should avoid it. If not, it's in your best interests to ensure that you fully understand what it is, how it works, and how to cancel it when you've met the requirements. If not, you may spend much more money than you wanted.
Are you looking to refinance or buy a new home? If it's your first time buying a property, you need to learn the differences, advantages and disadvantages between a fixed rate mortgage and a variable rate mortgage. Do not expect a definite answer to the question: what is the best mortgage type? The most reasonable response anyone can give is: it depends. The type of home loan you choose depends on your specific personal and financial circumstances. (read more)