You will probably have to pay mortgage insurance if you have borrowed money to buy your dream house. Private mortgage insurance (PMI) is needed for every conventional loan owner.
What is PMI?
PMI or Private Mortgage Insurance is a necessary expense when you apply for a mortgage. Almost all mortgage lenders charge the Private Mortgage Insurance payment if your initial down payment is less than 20% of the home value.
How is PMI Calculated?
For example, you plan to purchase a house worth $300,000. You will likely be able to pay $60,000 as a downpayment, which is 20% of your purchase price. Failing to pay the required down payment then the lender may charge you PMI in order to safeguard his loss.
PMI vs Homeowners Insurance
Private mortgage insurance (PMI) allows the lender to lend the buyer money with a lesser down payment. While homeowners insurance provides security to the buyer from any property damage.
How Much is Private Mortgage Insurance?
Private Mortgage Insurance costs between 0.5% to 1.5% per year on the actual loan amount.
Further to our earlier example, if get an approval of a $250,000 mortgage with a PMI rate of 0.5%, you could expect to pay $1,250 a year for PMI, or about $105 per month.
What Factors Determine the PMI Requirement?
The actuals of PMI depend on various factors. They are:
- Down payment: Every conventional loan requires 20% of the down payment. The lender will often demand PMI if the borrower puts down less than 20% of the home’s buying price.
- Credit Score: Borrowers with low credit scores need to pay a higher PMI rate.
- Loan Type: Certain types of loans, such as FHA loans, require mortgage insurance premiums (MIP) instead of PMI. The MIP rate and the requirements are decided by the Federal Housing Administration (FHA).
How to Avoid PMI?
Find out the best-suited PMI option for your reference.
- Higher Down Payment: Paying a higher down payment that is 20% of the home’s purchase price can help you to avoid the need for PMI altogether.
- Get a Piggyback Loan: This could be the way out. A piggyback loan is a second mortgage taken out at the same time as the first mortgage. Combining both mortgages would help you make a higher down payment and thus avoid PMI. For example, the borrower might take out a first mortgage for 80% of the home’s purchase price and a second mortgage for 10%, leaving a 10% down payment.
- Use a VA Loan: If you’re a veteran or an active-duty member of the military or defense department, you may be eligible for a VA loan, which does not require PMI.
- Lender-Paid PMI Options: Some lenders pay for the PMI in exchange for a slightly higher interest rate. While this can help you avoid the need for a separate PMI payment, it can also increase your overall mortgage costs.
PMI Insurance FAQs
1. When does PMI go away?
After you have reached 20% of the house equity you can request the lender to discontinue the PMI share. PMI is often canceled automatically once you’ve reached 22% equity.
2. Who does PMI benefit the bank or the borrower?
PMI is typically required by a lender when a borrower is unable to make a 20% down payment on a home purchase. The objective of PMI is to safeguard the lender in the event that the borrower misses a payment on their mortgage.
3. Does PMI go down as you pay?
Yes, once you have paid off a certain amount of your mortgage, you may request your lender to cancel your PMI.
The Bottom Line
PMI (Private Mortgage Insurance) is a type of insurance that benefits the lender or bank, not the borrower. The borrower may not immediately benefit from PMI, but it may allow him to qualify for a mortgage with a smaller down payment. PMI can be reduced as the borrower pays down their mortgage gradually. In some cases, the borrowers may be able to request PMI cancellation once they reach enough equity.
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