For many people, one of the largest obstacles in home buying is coming up with enough money to make a down payment. Private Mortgage Insurance (PMI) in one way for potential homeowners to overcome that roadblock.
Private mortgage insurance is intended to protect a mortgage lender from losing their money in case you fail to pay and they have to foreclose on the property. PMI is paid for by the borrower and is entirely separate from U.S. government-sanctioned agencies that provide mortgage insurance.
Whether or not you need private mortgage insurance as a new homeowner will depend on a few different factors. But first, it’s important to understand exactly how it works.
What is Private Mortgage Insurance, and How Does it Work?
Private mortgage insurance is for the mortgage lender’s benefit. Lenders typically issue loans no greater than 80% of the total cost of the home – this is to protect them in case the borrowers don’t repay. When a borrower can’t make the 20% down payment, the lender will require PMI because they are taking on a higher risk by accepting a lower upfront payment.
As the borrower, you’ll pay a premium to the lender on a monthly basis as part of your mortgage payment. This loan is only to protect the lender in case you default on the mortgage. It will not protect you from foreclosure or from other negative effects that come from falling behind on your payments.
How Much Does Private Mortgage Insurance Cost?
The cost of private mortgage insurance will depend on several factors, including:
- The Loan Provider: Rates will differ among providers depending on the industry and mortgage type.
- The Size of the Loan: The larger the loan, the higher the price of the associated PMI.
- Down Payment Amount: The more money you put down, the lower the price PMI will usually be.
- Your Credit Score: PMI will usually cost less if you have a high credit score.
- Mortgage Type: PMI on an adjustable-rate mortgage will typically be more expensive than on a fixed-rate mortgages, and you’ll find that premiums increase with the amount of coverage you require.
- Your Debt-to-Income Ratio: PMI will usually cost you less if you have a low debt-to-income ratio.
Taking all of these factors into account, the average cost of PMI generally ranges from 0.55% to 2.25% of the original loan amount.
You’ll likely find that there are various payment plans available, including:
- Monthly: Your annual amount is divided by 12 and added on to your monthly mortgage payment.
- Upfront: You pay the cost of the private mortgage at closing, which can help to maintain or even lower your monthly payments.
- Split Premiums: This option allows you to pay for some of your policy at closing, and have the remaining amount added on to your monthly payments.
- Lender-Paid: With this option, the lender will pay the premium, but you’ll be forced to pay much higher interest rates.
It’s important to note that mortgage insurance premiums are no longer tax-deductible, unlike your mortgage interest.
What to Consider Before Buying Private Mortgage Insurance
Before buying private mortgage insurance, there are a few things you’ll want to keep in mind. The most important factor being that it will add to the overall cost of your home. However, if you can afford the additional monthly cost, it can be an option that makes buying a home a reality.
If the additional monthly payments aren’t something you can take on, there may be other options available to you. These might include:
- Government Issued Loans: Both the Federal Housing Administration (FHA) and the U.S. Department of Veteran’s Affairs (VA) offer loans that can help make buying a home affordable. Not all potential home buyers qualify for these loans, but if you do, it can be a more cost-efficient option than private mortgage insurance.
- Pay a Higher Interest Rate: Occasionally, mortgage lenders won’t require you to purchase PMI even if you can’t make a 20% down payment if you’re willing to pay a higher interest rate.
- Take Time to Save: In some cases, it might be a better idea to take some extra time to save for a down payment and avoid private mortgage insurance altogether. But keep in mind that the housing market changes frequently, and the cost of your target home might rise in that time.
- Investigate Other Markets and Homes: If the home you’re looking for is out of reach, you might want to refine what you’re searching for. The same home may be considerably less expensive in a nearby city. Or you can investigate smaller homes in your target market.
When Can I Stop Paying PMI?
You’re typically able to cancel your private mortgage insurance once you have more than 20% equity in your home. What this means is that once the difference between your remaining mortgage balance and the market value of your home reaches 20% of your original mortgage loan, then you should be eligible to discontinue paying PMI on that loan .
You’ll likely find that there are other conditions you need to meet, however, including a consistent history of making on-time mortgage payments. While you may hit the 20% equity mark, you may need to demonstrate that you are a reliable borrower in the meantime.
Can I Avoid Getting PMI Depending on My Credit Score?
If you have a credit score that qualifies you for exemption with a particular lender, you may be able to qualify for an 80/20 mortgage. These mortgages allow qualified borrowers to take out a mortgage for 80% of the total cost and a second loan to cover the 20% down payment.
Because there is a higher risk for the lender with 80/20 loans, there are usually very strict requirements borrowers must meet to be approved. Borrowers typically need to have a specific, typically high, credit score, meet certain stipulations about savings and assets, and have a low debt to income ratio. Both the mortgage and the 20% loan will be secured against the home, so the risk of foreclosure is also higher.
Alternatively, if you have good credit. you may qualify for an 80-10-10 loan. With these loans, the mortgage covers 80% of the total cost of the home, an additional loan (like the 80/20 loan) covers an additional 10%, and you then provide a down payment to cover the final 10%. These loans are usually easier to qualify for than 80/20 loans, and can help you avoid PMI.
The Bottom Line
While private mortgage insurance does add to the overall cost of buying a home, it makes homeownership a possibility for the many people who can’t afford to make the 20% down payment. For that reason, it’s an option worth investigating for anyone interested in buying their own home.
