Private mortgage insurance (PMI) is an often-overlooked cost that homeowners may need to pay when buying a home with a conventional mortgage or refinancing that loan. Understanding PMI can help you to avoid paying it or saving money in the long term. Here’s what you need to know:
PMI is a fee that you are usually required to pay if you have a conventional mortgage loan and you are unable to put 20% down. You may also need to pay it if you refinance and your equity is less than 20% of the value of your home. PMI protects the lender if you stop making payments on your loan. However, it doesn’t protect you, and you are still at risk of foreclosure if you can’t make your payments.
PMI can have an annual cost ranging from 0.25% to 2% of the mortgage loan balance, depending upon the size of your down payment, the amount of your loan, the loan term, and your credit score. For example, let’s say that you had a 1% PMI fee on a $200,000 loan. That fee would add approximately $2,000 a year/$167 a month to the cost of your mortgage. Unlike paying your mortgage principal, which goes toward building equity or mortgage interest, which is tax-deductible, PMI is simply a fee that doesn’t provide a return on investment for you.
While there are several ways to pay your PMI, the most common method is a monthly premium added to your mortgage payment. Some lenders will offer other payment options, including one upfront premium at closing, or paying a portion of that premium at closing and the rest monthly. Review your loan estimate and closing disclosure to get an accurate breakdown of what you’re being charged for PMI.
The easiest way to avoid PMI is to have a 20% down payment. If that isn’t possible, there may be other types of loans available that don’t require PMI. Some lenders will offer loans with smaller down payments and no PMI, but they are also likely to have a higher interest rate. Whether this type of loan makes sense for you will depend on factors including how long you plan to stay in your home. Because mortgage interest is tax-deductible, talk to your tax advisor when trying to determine which option is right for you.
Other options such as Federal Housing Authority (FHA) loans allow you to avoid PMI while paying less in interest and less upfront. These savings are made possible because the federal government helps guarantee the loans, reducing the risk to the lender. These loans will be dependent on factors, including your credit score, the lender, and market conditions.
BYE-BYE PMIEven if you don’t request it, your lender is required to drop the PMI when your balance equals 78% of your home’s original purchase price.
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The good news about PMI is that it doesn’t last forever. The key is to build up 20% equity in your home. How long this takes will depend on your mortgage. However, you can get out of PMI sooner. The trick is to reach the 80% equity level as quickly as possible. There are a few ways to do that:
PMI is an added monthly expense that you can avoid if you save enough to put 20% or more down for a mortgage. While waiting to save that amount can seem tedious, there are additional advantages. If you continue to rent, you won’t be paying insurance, property taxes, or maintenance fees. If you settle for a less expensive home, you’ll save on PMI and a larger mortgage payment.