PMI stands for private mortgage insurance. It’s a type of insurance required by mortgage lenders when homebuyers put down less than 20 percent of the purchase price of the house in question. It’s designed to protect lenders in the event the homeowner defaults on the loan, says Bankrate.
Because the homeowner has less than 20 percent equity stake in the house, PMI will offset the lender’s level of risk. PMI is not designed to protect the buyer, but it does provide a way for them to at least purchase a home even though they don’t have that 20 percent to put down. It’s really a win/win. But you don’t have to pay PMI forever. More on that later…
Cost of PMI
PMI can be a pretty big expense, with the average annual PMI premium ranging from .55 percent to 2.25 percent of the original loan amount per year. Your credit score and loan-to-value ratio will impact your PMI premium. For example, if you buy a home for $200,000 and your PMI is one percent, you will pay $2,000 a year, or about $166 a month.
The good news is that you can ask the lender to cancel your PMI once you have paid down the mortgage balance to 80 percent of the home’s original appraised value. For Federal Housing Administration (FHA) mortgaged homes, the rules are different. If you have an FHA loan, you will need to pay down your mortgage to 78 percent of your original sales price. Even if appreciation has pushed your equity up, you will need to reduce your original principal balance.
Do All Lenders Require PMI?
Generally, most lenders require PMI when it comes to conventional loans with a down payment less than 20 percent. Like anything else, though, there are exceptions to the rule. You’ll have to do your homework if you want to forgo paying PMI.
Some banks out there offer low down-payment, PMI-free conventional loans. These providers will waive PMI for borrowers with less than 20 percent down, but you’ll pay a higher interest rate. Knowing when this option makes sense in the end is up to you – you’ll have to do the math on that.
There are also solutions for low-income borrowers with three percent down and no PMI requirements. Additionally, VA loans don’t require PMI, so this is a good option if you don’t have a large down payment.
Paying for PMI
There are many ways you can pay for PMI. Some lenders offer you a few options, while others don’t. Don’t agree to a mortgage until you ask each lender what choices they offer.
The most common way to pay for PMI is through a monthly premium that is added to your mortgage payment. Other times, you can pay for PMI with a one-time up-front premium paid at the time of closing. And still other times, you can pay PMI with a combination of both up-front and monthly premiums.
Before Choosing a Lender…
- Shop around. Don’t settle for the first lender that pre-approves you for a mortgage, as you may pay more than you should in interest and mortgage insurance. You should compare at least three different lenders before making a decision.
- Try to increase your down payment to at least 20 percent in order to lower your monthly payments in the long run. Or, you could purchase a less expensive home.
- Consider other types of loans. Yes, conventional loans are the most popular but there are many other options, such as FHA and VA loans that could be better for you.
Contact Berkshire Hathaway
To learn more about PMI and other requirements of financing a home, contact the professionals at Berkshire Hathaway. Our licensed Realtors are here to guide you every step of the way.