All About Private Mortgage Insurance (PMI)

If you find yourself in the market for a new home, it is obvious that you will need some money available to use as a down payment when you get to closing. As far as the industry goes, there is an age old adage that says a new home buyer should have at least 20% in reserves to pay when they get their new home. But why 20%? Isn't that a tad high?

Well, the reason for this is Private Mortgage Insurance, or PMI, and if it ends up that you are unable to make a down payment of at least 20% of the sale price, you'll be required to obtain private mortgage insurance from your lender. But what is PMI, and why are you paying for it?

In the most basic sense, PMI protects the lender in the event that you default on your mortgage. Unfortunately though, it doesn't protect you from anything. How much you will pay in PMI charges will vary depending on the size of your loan, the size of your down payment, and even the lender you use. Generally, the charge is equal to about one-half of one percent.

For example, let's say you bought a home for $100,000 and were only able to put down a total of ten% ($10,000).  The loan amount would be $90,000 and the lender would calculate you monthly PMI by multiplying $90,000 by 0.005.  The end result would be an annual PMI charge of $450, which would add an additional $38 (approximately) to your monthly bill. But that's enough math.  Let's talk about how long you actually have to pay for PMI.  This is where the 20% comes in.

Luckily for you, PMI isn't charged forever.  In most all cases, PMI is automatically dropped from your loan once you have paid down you principle balance by 20%. If you're close to reaching this figure, it is worth calling your loan servicer and making sure your PMI is removed at this point. Also, luckily for you, if your home appreciates to the point where  your equity is over twenty percent, you can have the PMI charges dropped too. Obviously you will need a new appraisal to get this accomplished (which will run you a few hundred dollars) but you will quickly make that back by having your monthly payment reduced, if you do in fact proved that your home's value has increased.

You should also be aware that, while the interest you pay on your mortgage is usually tax-deductible, PMI is not.

So what happens if you simply cannot afford to put 20% down on your mortgage and you really just don't want to pay PMI? Well, fortunately there are a couple of options at your disposal.

TIPS FOR AVOIDING PMI

The main way to avoid paying for PMI to take out an "80-10-10" loan, which involves getting two mortgages rolled into one.  The main loan would be 80% of the total sales price, the second mortgage would be 10%, and the last 10% would be your down payment.  It is likely that your second mortgage would have a slightly higher interest rate, but since the amount you are borrowing is much less, it would still be lower than paying one single mortgage with PMI.  You also could see additional savings because all of your interest would be tax deductible.  Yay!

 

Another way to get around paying for PMI is to take out a loan with a higher interest rate. Most lenders will agree to waive this charge if you pay the higher rate until your equity gets to 20%.  Once you reach that mark, your interest rate would be lowered.

The rate increase you would see will typically range anywhere from 0.5 to 1 percentage point.  Usually the higher your down payment, the lower the increase.  Again, the advantage to doing this is that the added interest is tax-deductible.

So in conclusion, PMI is just one of those things you are probably going to have to deal with if you are taking out a home loan and don't have enough cash on hand to make a down payment of at least 20%. But don't worry, probably anyone you know that has a house has had to deal with it.  And like I said, it automatically goes away when you pay down your mortgage enough.

As always, if you have any questions about PMI, don't hesitate to CONTACT US and we will get back to you as soon as possible!
- Pate