What Is PMI: Know What You’re Paying For
When taking out a mortgage, sometimes you’ll be required to pay for private mortgage insurance, also known as PMI. This payment is usually required as part of your mortgage, especially if you make a down payment for less than 20% of your home’s purchase price.
In this guide, we’ll cover everything you need to know about PMI and discuss its various types. We’ll also go over the reasons why you have to pay for mortgage insurance, whether it has any benefits for you, as well as reasons to avoid being saddled with PMI costs – including tips on how to avoid paying for it.
Private mortgage insurance (PMI) is a type of mortgage insurance that borrowers may be required to buy when applying for a loan. Private mortgage insurance protects the lender from losses if the buyer ends up defaulting on the loan.
Generally, a borrower is required to buy PMI when they make a down payment of less than 20% for their home. This means that the mortgage’s loan-to-value (LTV) ratio is more than 80%. The larger the LTV, the more wary lenders are of the buyer, which is why lenders decide to have the buyer pay for PMI.
When lenders give out a loan, they are always concerned with how and if they’ll get their money back. If a homebuyer pays less than 20% on their down payment, they might be considered less likely to make mortgage payments on schedule. In order to make sure that their investment is protected, lenders require the borrower to pay for a PMI on top of their loan.
Private mortgage insurance (PMI) helps the lender cover their loss if you default on your loan. So if they end up foreclosing on your home, the mortgage insurance company will cover a certain percentage of the insured mortgage. Essentially, mortgage insurance means you’re paying to compensate the lender for taking the high risk of lending their money to you.
The cost of PMI will differ depending on a variety of factors. These factors include your loan amount, the size of your down payment, and your credit score. Other factors like the loan being for an investment property or a second residence also come into play. Generally, the cost is around 0.25 to 2 percent of your loan annually.
The riskier you look to a lender, the higher your premiums will be. Therefore, having a good credit score and a higher down payment helps. You stand a better chance of paying less mortgage insurance premiums with a better credit score and if you pay more on your down payment.
Another thing to note is that annual mortgage insurance is recalculated each year, so as you pay off your loan, your PMI premiums will go down.
If you’re paying for borrower-paid mortgage insurance, lenders are required to cancel your PMI when you have 22% equity in your home. You can send in a written request for cancellation when you reach 20% of your home’s purchase price in home equity, but it’s not a guaranteed cancellation.
Furthermore, some lenders may also allow you to cancel your PMI early if you prepay on your mortgage and have at least 20% home equity. An important thing to keep in mind is that in order to terminate PMI, your mortgage payments must be current.
In addition, your lender is obligated to tell you how long it’ll take for you to qualify for private mortgage insurance cancellation. Information on how to cancel your PMI must also be given each year. In the case of lender-paid mortgage insurance, you’ll be paying for the mortgage insurance premium with the built-in higher interest rate. Essentially, if you choose an LPMI you’ll be paying for PMI until you pay off the loan.
If you opt for a split premium PMI, you’ll pay part of your premiums upfront and you’ll pay the rest monthly like a BPMI. On an MIP, the buyer needs to pay the premium throughout the life of the loan. An exception is given to buyers who pay more than 10% on their down payment, where they can stop paying MIP after 11 years.
While it seems like private mortgage insurance only benefits the mortgage lender, there are a few benefits you can gain from PMI. For one, you stand a better chance of buying a house earlier. The extra safety net provided by mortgage insurance helps lenders to feel safer giving loans to people who pay smaller down payments. With PMI, lenders can approve a home loan with down payments as small as 3%. This decreased cost of entry also gives you more options for a home since you’re no longer tied to the 20% down requirement.
Being able to buy a new home quicker also gives you the advantage of building home equity earlier. Instead of paying rent during the time you’re saving up for a 20% down payment, you can use the money to build equity by paying your lender. Paying less down payment would also mean that you have more money saved up. Rather than exhausting your savings and leaving yourself financially vulnerable, you can build an emergency fund with the money you save.
Some mortgage insurance providers also offer protection options. Some insurance companies offer job loss protection as part of your PMI coverage, which allows your insurance policy to cover your mortgage payments until you find work again.
Depending on the insurance company you choose, they can also offer a safety net called a partial claim advance. A partial claim advance protects you from foreclosure by having the insurance company pay the lender if you default on your loan. While this means you have to pay money to the insurance company, this can allow you some breathing room and will reduce the risk of losing your house.
Even if private mortgage insurance does have some benefits, having mortgage insurance means paying more on top of your mortgage payments. With a rate of 0.25 to 2 percent of your loan per year, that’s money given away mostly to protect your lender.
Despite ‘insurance’ implying that the insurance holder’s family receives monetary compensation if they die, the lender is the only beneficiary of the mortgage insurance. If you want to protect your family in case of anything, you need to have a separate insurance policy called mortgage protection life insurance.
Another fact to keep in mind is that private mortgage insurance isn’t tax-deductible since 2018, which means you’ll pay more tax by having PMI. Additionally, PMI isn’t easy to cancel. Many lenders require you to send in a written request to cancel your PMI, and the process can take several months. Also note that in this period, PMI still needs to be paid.
Choosing to take mortgage insurance might allow you to buy a house quicker, but it’s important to consider the costs that will be incurred during the life of your loan. Whether you decide to take the PMI and buy your home early or to save up for a bigger down payment, the right decision will depend on your circumstances.
We understand that these options may be overwhelming, that’s why we’re here to assist! Reach out to us at Wesley LLC and our professionals will be more than happy to help you choose the option that best suits your needs.