What is Private Mortgage Insurance?
Buying a home is an exciting milestone, but it can also come with some added costs, including Private Mortgage Insurance (PMI). If you’re a first-time homebuyer or just starting to explore mortgages, understanding PMI is essential.
What is PMI?
Private Mortgage Insurance (PMI) is a type of insurance that protects the lender, not the borrower. It is typically required when a homebuyer makes a down payment of less than 20% of the home’s purchase price.
Since smaller down payments pose more risk to lenders, PMI helps offset the risk by ensuring the lender will be compensated if the borrower defaults on the loan.
When Do You Need PMI?
If you’re applying for a conventional loan and cannot put down at least 20%, your lender will likely require PMI. While it increases your monthly mortgage payments, PMI allows you to become a homeowner sooner rather than waiting to save a larger down payment.
How Much Does PMI Cost?
PMI costs vary based on several factors:
- Loan amount: Higher loan amounts result in higher PMI premiums.
- Down payment: The smaller the down payment, the higher the PMI cost.
- Credit score: Borrowers with higher credit scores generally receive lower PMI rates.
The average annual cost of PMI is between 0.46% and 1.5% of the loan amount. For example, if you take out a $200,000 loan, PMI could cost around $920 to $3,000 per year, or $77 to $250 monthly.
How Do You Pay PMI?
Here are a few ways PMI can be paid:
- Monthly Premiums: Added to your monthly mortgage payment. The most common method of paying PMI.
- Upfront Premium: Paid as a one-time fee at closing.
- Combination of Both: A portion paid upfront, with the rest spread across monthly payments.
Can You Avoid PMI?
There are a few ways to avoid PMI:
- Make a 20% Down Payment: Putting down 20% eliminates the need for PMI altogether.
- Piggyback Loans: This involves taking out a second loan to cover part of the down payment.
- Lender-Paid PMI: Some lenders offer this, but it usually comes with a higher interest rate.
How to Get Rid of PMI
The good news is PMI isn’t permanent. Here are ways to remove it:
- Reach 20% Equity: When your loan balance reaches 80% of the home’s original value, you can request your lender to cancel PMI.
- Automatic Cancellation: Lenders have to cancel PMI automatically once you reach 22% equity.
- Home Reappraisal: If your home’s value increases, a new appraisal might show you’ve reached 20% equity sooner.
Is PMI Worth It?
While PMI adds an extra cost, it also opens the door to homeownership sooner. For buyers who don’t want to wait years to save a 20% down payment, PMI can be a helpful tool. Additionally, in some cases, the extra appreciation of a home’s value can offset the cost of PMI.