Private mortgage insurance is a way for homebuyers who can’t come up with a full down payment to still qualify to purchase a home. If you’re looking to buy a home and find yourself in this situation, it can be easy to overlook the financial ramifications of PMI and get caught up in the excitement of buying a home. Although PMI insurance can help you get the home of your dreams, it does come with added costs and restrictions. Make an educated decision before you buy a home and learn what you need to know about mortgage insurance.
What Is PMI?
PMI is private mortgage insurance that’s used with conventional loans. Insurance companies provide PMI, which is arranged by your lender to protect them if the borrower stops making payments. But this only applies to mortgages in which the down payment was less than 20 percent of a home’s purchase price. It’s also used when a lender refinances a mortgage in which the borrower has less than 20 percent home equity.
What to Know About Private Mortgage Insurance
Learning about PMI prior to making an offer on a house or refinancing your mortgage can help you make the best decision for your financial situation. Here’s everything that a prospective homebuyer needs to know about PMI.
1. How to Avoid PMI
The best way to deal with PMI is to avoid it altogether by putting down the requisite 20 percent. In real-estate terms, this requires having a loan-to-value (LTV) ratio of 80-20 or less, meaning you are borrowing 80 percent of the value of your home. If you don’t have the cash yourself, you can wait and save up, or find the money from another source.
Some lenders will offer loans with less than 20 percent down in exchange for a higher interest rate. Other types of loans, such as Federal Housing Administration loans, don’t require PMI but might have other costs.
2. PMI Protects Your Lender, Not You
Though you pay for it and it increases the cost of your loan, PMI does not protect you — it protects the lender. If you default on your mortgage payments, you could face foreclosure that could negatively impact your credit, whether you have PMI or not.
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3. PMI Is Not the Same as Mortgage Life Insurance
Do not confuse PMI with mortgage life insurance, which pays your mortgage off if you die. Remember, PMI protects the lender, whereas mortgage insurance — sometimes called mortgage protection insurance — is a way for you to protect your heirs in case you die before your mortgage is paid off. PMI allows you to buy a home with a smaller-than-usual down payment, whereas mortgage insurance ensures that your mortgage debt will be paid off if you die.
4. PMI Might Be Tax-Deductible
The tax-deductibility of PMI is something of a gray area. Previously, PMI was deductible on mortgages that were taken out on or after Jan. 1, 2007. The deduction was reduced by 10 percent for every $1,000 a taxpayer’s adjusted gross income exceeded $100,000, vanishing completely for AGIs over $109,000. That tax break expired at the end of 2016, though. Congress can enact legislation to renew the deductibility of PMI at any time, so talk to your tax advisor for the most up-to-date status of the answer to the question, “Is PMI deductible?”
5. Some Homebuyers Want PMI
Is a PMI mortgage worth it? For some homebuyers, the answer is “yes.” PMI might seem like a strange thing to want because it increases the cost of a mortgage. PMI also allows homeowners to buy homes if they can afford the monthly payments but do not have enough cash for a 20 percent down payment.
Only you can decide whether the additional cost of PMI makes financial sense when you buy a home. Doing your research and asking lenders questions about PMI can help you make a more informed decision. Remember not to reach for a home you can’t afford just because PMI allows you to buy it.
How to Get Rid of PMI
Options for getting rid of PMI include the following:
- Paying a higher down payment
- Getting a higher-rate loan
- Getting an FHA loan
- Having a loan-to-value ratio of less than 80 percent
- Getting to the halfway point of a mortgage
Understanding how PMI works, and how to potentially avoid this added expense, might save you money. Here are more details on your options for eliminating PMI:
Find a Lender Who Will Work With You
An option for PMI removal is to work with a lender who can structure a loan for you that doesn’t require PMI, even if you put less than 20 percent down. Not all lenders will do this, but if you find one that does, be prepared to pay a higher interest rate on your mortgage. If you opt for this route, calculate the total amount you’d be paying under both scenarios — PMI plus a lower-rate loan versus no PMI plus a higher-rate loan — to determine which is more financially prudent.
Get an FHA Loan
FHA loans are another option if you’re making a low down payment, as they don’t require PMI. However, FHA loans do require a mortgage insurance premium, which is essentially the same type of mortgage insurance that PMI provides. Rates can be lower or higher than what you’d face if you took out a conventional loan and paid PMI.
Once the amount of your outstanding mortgage falls to 78 percent of the value of your home, your lender must automatically terminate your PMI payments. You can also request termination in writing when your loan-to-value reaches 80 percent. If your home value has risen significantly and you can refinance with a loan that is less than 80 percent of the value of your home, you are no longer required to pay PMI. Making additional payments toward the principal of the mortgage is another option, thereby reducing the amount you owe relative to the value of your house.
A final way to remove your PMI is with time. Lenders must automatically remove PMI once you reach the midpoint of your loan period. For example, if you have a 30-year mortgage, once you reach the 15-year mark, your PMI must automatically end, even if you haven’t reached the 78 percent LTV threshold.
Related: How to Qualify for an FHA Loan
How Much Is Mortgage Insurance?
So how much is PMI? It depends. Borrowers should expect their PMI to cost between 0.3 percent and 1.15 percent of a home loan amount, according to Realtor.com. The actual figure depends on your credit score and your total down payment amount. You can estimate your PMI cost using an online PMI calculator to get a better idea of how much you will pay.
To calculate how much PMI you’ll owe, take the amount of your outstanding loan and multiply it by the PMI rate. The resulting figure is your annual mortgage insurance payment. For example, if a lender has a PMI rate of 0.50 percent and you owe $250,000 on your loan — after your down payment — multiply $250,000 times 0.50 percent to get your annual payment amount of $1,250.
How Is PMI Paid?
Traditionally, there are three ways to pay PMI:
- Combination of upfront and monthly
PMI costs are known as premiums, and there are several ways to pay for premiums. Monthly premiums are added to your monthly mortgage payment, but upfront premiums get paid at closing. If you move or refinance, however, you might not receive a mortgage insurance premium refund.
The most common way to pay PMI is to simply have it added to your regular, monthly mortgage installment. With an upfront payment, you pay the entire amount of your PMI at the time you take out your loan. A combination payment is somewhat akin to your mortgage loan — you’ll pay part of the PMI upfront as a down payment, then you’ll pay the balance off with your monthly installments. Some insurance companies give borrowers a choice as to how to pay, so ask your lender if this is an option.
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