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Last updated on December 5th, 2022 at 10:05 pm
If while purchasing a home your down payment is less than 20% you may have to pay extra for an insurance policy.
What is PMI and how does it work?
Private mortgage insurance gives you the benefit of buying a home without paying the traditional 20% down payment. You’ll be paying the additional monthly premium for mortgage insurance.
Any conventional mortgages with smaller down payments require a PMI and help first-time buyers to become homeowners.
Lenders who offer lower down payment financing options are protected by PMI.
The lenders consider you a riskier borrower with a greater chance of defaulting on your mortgage when the downpayment is less than the traditional 20%.
If the default happens, the lender could use the escrowed PMI payments to recover some of their loss.
How much does a PMI cost?
According to Freddie Mac on average the borrowers with PMI pay between 0.5 and 1.5% of the loan amount annually, or between $30 and $70 monthly for every $100,000 borrowed.
If the loan amount is $250,000 with a 5% down payment, PMI would add between $1,188 and $3,563 per year or approximately $100 to $300 on your monthly mortgage payment.
The monthly or yearly payment of PMI varies by the lender. Some may allow you to make a partial upfront payment at closing so that it lowers your monthly or annual PMI payments.
Ways to lock in a low PMI rate
- Higher credit score.
- Close to a 20% down payment.
- Owner-occupied property rather than rental or investment properties.
When can you stop paying PMI?
Once you have at least 20% equity in your home either by paying down the principal or by increasing your home’s value you can stop paying PMI.
Some lenders might include making a set number of mortgage payments, or getting a new appraisal, or owing less than 80% of your loan principal as an obligation before stopping PMI.
Once you have reached the 80% loan-to-value threshold you can request a PMI cancellation in writing. The specific requirements as laid out by the Consumer Financial Protection Bureau, are:
- A record of good payment history
- No default in current loan status
- There should not be a subordinate loan in equity.
- Proof of value to be submitted through an appraisal.
Borrowers with Fannie Mae or Freddie Mac mortgage have a different threshold, the equity must be at least 25% before PMI can be terminated.
The advantages of PMI
- You can buy a home sooner without the tradition of 20% down.
- You’re able to build wealth sooner and increase your net worth.
- It’s only a temporary cost till an 80% LTV ratio
If you file an itemized tax return then PMI is tax-deductible
The disadvantages of PMI
- It’s an extra expense each month.
- PMI rates may be high depending on your credit score, home occupancy, down payment amount, and equity appreciation. Resulting in raising your monthly mortgage payment.
Canceling PMI needs a formal request in writing, which takes time to process and remove.
Do all home loans require PMI?
PMI is required only for conventional mortgages, other mortgage types have their own version and own sets of requirements.
- Conventional mortgages: If you paid less than 20% down on a conventional loan, expect to pay PMI.
- FHA loans: Can borrow with as little as 3.5% down but has a monthly insurance premium or MIP. All MIP requires advance payment at closing followed by regular monthly or annual payments.
- USDA loans: Even if it does not require a down payment, there is a mortgage insurance requirement and upfront and annual fees.
- VA loans: There is no mortgage insurance requirement with this loan, but a one-time origination fee between 1.4 and 3.6%, depending on the down payment amount to be paid along the loan amount.
ARM loans: An ARM, or adjustable-rate mortgage, may also include PMI, but you may be able to build equity faster, so you can get rid of PMI faster than with a fixed-rate mortgage.
Reference Source: Cnet
