Private mortgage insurance or PMI, is the boogeyman of home buying. Conventional advice urges buyers to put 20% down on a home just to avoid incurring this dreaded insurance payment. While adding another expense to purchasing a home isn’t ideal, does PMI have an unwarranted bad rap?
What is private mortgage insurance?
Private mortgage insurance is a type of insurance that safeguards the lender in case you default on the loan. Homebuyers with a down payment of less than 20% are usually required to pay PMI if they are getting a traditional mortgage. How much you pay will depend on a number of factors, including your credit score and the size of your loan. Use this PMI calculator to get a rough estimate.
Not all mortgages with down payments under 20% are subject to PMI. Private lenders may opt for charging higher interest rates instead of PMI for those making a smaller down payment.
Other loan types may not require PMI specifically, but do require payment of a different form of mortgage insurance. For example government backed loans (think FHA loans) may require an upfront mortgage insurance premium or MIP. An MIP is paid as part of closing costs and includes a monthly payment on top of your principal loan.
Should you avoid paying PMI?
Whether or not you should avoid PMI depends on your individual needs and finances. Standard advice for a conventional loan would say to save for the 20% down payment to avoid PMI, but that could put owning a home out of reach for many.
In fact, putting 20% down on a home is far from the norm. According to a study from NerdWallet, the median down payment for first time homebuyers was just 7%. Additionally, the National Association of Realtors found that 81% of homebuyers in 2016 put less than 20% down.
The benefits of paying a larger down payment include access to lower mortgage interest rates and lower monthly payments. However, opting to pay less up front and pay PMI allows prospective buyers to own sooner in exchange for a higher monthly payment.
It’s important to note that homeowners won’t need to pay PMI forever. Below are a few ways your PMI can be cancelled if you are up to date on mortgage payments:
- Mortgage servicers are required to automatically cancel PMI when the outstanding balance on your home loan drops to 78% of the original value of the home. For example if the purchase price of your home was $300,000, PMI will be cancelled when your outstanding loan balance hits $234,000.
- Hit your mortgage midpoint. Lenders are required to remove PMI once homeowners have hit the half way mark on their mortgage. For a 30 year fixed loan, this would mean PMI would be removed after 15 years.
- Refinance your mortgage. This option is a bit trickier as you’ll need to pay closing costs. It may not be worth shelling out thousands of dollars to refinance for the sake of eliminating monthly PMI. If you’ve made improvements to your home, you may have racked up enough equity to waive PMI, but you’ll need to evaluate whether or not those savings justify the cost of refinancing.
Know your rights as a homeowner
The Homeowners Protection Act of 1998 (also known as the PMI Cancellation Act) protects homeowners from paying for excessive PMI coverage and establishes federal guidelines for cancelling PMI. Prior to the passing of this legislation, homeowners had little recourse if their lender refused to cancel their PMI coverage.
Before signing a mortgage with PMI, ask your lender to provide you with a clear, written explanation of the terms and payment schedule. This will make it easier to track when you’ve hit the benchmarks required to cancel PMI. If you find the lender is in violation of the HPA, report them to the Consumer Financial Protection Bureau.
Since PMI is temporary, many buyers feel the tradeoff is worth it to pay a bit more initially to own a home sooner. Work with your lender to find the best arrangement for your needs.
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