Buying a house is one of the most significant purchases many people will ever make, which is why it is crucial to understand all of the costs associated with a typical transaction. In addition to your down payment, there are fees for inspections, closing costs, and even private mortgage insurance (PMI) to be aware of. If you are a first-time homebuyer, you may be wondering, “what is PMI?” It’s never wise to run into any real estate transaction without the proper planning, so knowing what PMI is in real estate can be a helpful tool for navigating the housing market.
Depending on your lender and the size of your down payment, you may be required to pay PMI in addition to your home loan. This can impact your monthly mortgage payment and even your ideal price range for the property. In this article, we’ll explore what PMI is, how a PMI mortgage works, as well as how to avoid different types of PMI. Read on to learn more about PMI and know when it applies to you.
What Is Private Mortgage Insurance (PMI)?
Private mortgage insurance (PMI) is a cost required by most mortgage lenders when a down payment does not equal at least 20 percent of the purchase price. The reason for PMI is that buyers with a low down payment are considered a higher risk by lenders for potentially defaulting on a payment. Buyers are then required to pay an extra monthly premium in the form of PMI. If the buyer defaulted on the home loan, the insurer would repay the mortgage lender a portion of the loan balance. While it’s possible to see a mortgage with PMI required within some real estate transactions, they tend to be common for those that might be purchasing their first home.
It is important to note that PMI does not last for the entire lifetime of the home loan. Depending on your lender, the payment could either drop off when you reach a certain amount of equity in the house or when you refinance. The requirements for PMI are only applicable for traditional home loans. Other loan types (such as FHA loans) have different protocols for smaller down payments.
How Much Is Private Mortgage Insurance (PMI)?
For those wondering what PMI is and how much it might cost, the cost of PMI will depend on the size of your home loan, though it typically ranges from .5 to one percent of the total loan amount. Bankrate estimates this amount at between $30 and $70 for every $100,000 borrowed. The exact payment will depend on a few different factors:
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Down Payment Amount
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Credit Score
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Type Of Loan
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Down Payment Amount
The down payment amount is the most significant determining factor when setting a PMI premium. Similarly to traditional insurance structures, when a lender makes a larger down payment signifies a lower mortgage balance and consequently a smaller PMI bill. On the other hand, if your down payment is a smaller percentage of the purchase price, you will pay more PMI. This is because a smaller down payment typically signals a higher risk to mortgage lenders.
Credit Score
Credit history also plays an important role in determining a PMI premium. Lenders want to make sure that borrowers have a history of making payments on time. They also want to check if borrowers typically take on more debt than they can afford or max out their credit lines. These factors are used by lenders to evaluate risk when providing a home loan and can result in a higher PMI payment.
Type Of Loan
Depending on whether you have an adjustable or fixed-interest rate loan, your PMI payments could be different. Traditionally, a fixed-rate loan is associated with lower PMI premiums because there is less variability in the monthly payment. With an adjustable interest rate, insurers may charge more to protect the lender from periods where the interest could increase.
Is PMI Tax Deductible?
If you’re first asking what private mortgage insurance is, it’s natural to consider the potential tax benefits of paying this insurance. PMI is tax-deductible for homeowners who opt for itemized deductions rather than standardized deductions. Currently, the standardized deduction is at $12,550 for single individuals or $25,100 for couples filing jointly. It is more common to take the standardized deduction, which means PMI would not be deductible. There is also an income requirement to keep in mind. Individuals cannot deduct PMI if their adjusted gross income exceeds $109,000.
How To Make PMI Payments
There are three main ways to make PMI payments: an annual lump sum, monthly, or a combination of the two. Homebuyers can choose to pay a lump sum once a year, but this is not always recommended. The reason is that PMI payments are not refundable, so if you plan on refinancing, you could lose some of those funds you have already paid.
A more common option is to pay PMI monthly along with your mortgage payment. When you make the monthly payment, your lender will break down each portion of the amount due. Many homeowners prefer this setup to avoid a lump sum payment. However, buyers who can pay some upfront costs can make a partial payment and spread the rest out monthly. Talk with your lender to determine the best payment schedule for your financial situation.
Advantages Of Paying PMI
PMI has one main advantage to be aware of: it can help aspiring homebuyers purchase a property with a smaller down payment. The down payment is typically the biggest obstacle when buying a house, and it can take years to save up. While PMI is an additional monthly cost, the benefit is that you can purchase property sooner than if you waited to save 20 percent of the full property value.
Real estate is historically a high-performing investment, and the sooner you can purchase property, the sooner you can begin to experience the benefits of homeownership. This can make PMI a somewhat beneficial addition to your home loan, despite the added cost. A home that you’d potentially not need PMI for in five years can be yours much faster, building your credit along the way.
How To Avoid PMI
The thought of an additional monthly cost can be discouraging as you navigate the home buying process for the first time. As we’ve mentioned, there are mortgages without PMI insurance required, it mainly comes down to the financial health of the buyer and their ability to pay a down payment. There are several ways to avoid PMI, some of which include:
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20 Percent Down: The number one piece of advice to avoid PMI is to put more than 20 percent down. If you are buying a $350,000 house, that means you need at least $70,000 available for the down payment. This strategy typically requires diligent savings practices, but it can be done with proper planning.
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Piggybacking: One option for avoiding PMI is by “piggybacking” or combining two loans. Homebuyers can apply for the first loan (often at a higher interest rate) to put 20 percent down when purchasing a house. The second loan is the mortgage, which will have a lower interest rate and no PMI.If lenders can make timely payments for both loans, this can be a sound strategy for avoiding excessive PMI payments each year.
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Government Backed Loans: There are certain government-backed loans, such as a VA loan or FHA loan, that do not require a 20 percent down payment. Research the eligibility requirements and find a lender that provides the loan type you are interested in. This can be a great way to purchase property without a large down payment or PMI.
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Nontraditional Lenders: Certain online mortgage lenders, such as Quicken Loans, are beginning to waive PMI for homebuyers in exchange for a higher interest rate. While these borrowers will not pay monthly PMI, it is important to consider the long-term costs of a higher interest rate.
How To Avoid Borrower-Paid PMI
Borrower-paid PMI is typically what people are referring to when discussing monthly PMI payments. This type of PMI is lumped together with mortgage payments and automatically drops off once borrowers reach 22 percent equity in the home. Borrowers can also request to remove PMI once they reach 20 percent equity. Borrower-paid PMI can be avoided using the strategies discussed above, such as making a larger down payment, piggybacking home loans, or using a nontraditional or government-backed lender.
How To Avoid Lender-Paid PMI
In some cases, lenders can pay the entire PMI premium in exchange for a higher interest rate on the loan. This can result in more money paid over time, so it is important to review your amortization schedule if you opt for lender-paid PMI. One way to avoid this is by paying the entire premium yourself at the time of closing, though the amount required may be challenging to come up with. Note that when paying PMI at one time, you cannot get that money back if you were to refinance the home loan.
How To Get Rid Of PMI
It is crucial to understand the different ways you can get rid of PMI, as this information will save you money in the long run. Homebuyers will typically need to reach out to their mortgage lenders to start the process, which can be done once you reach 20 percent equity in the home. It’s always smart to keep an eye on the payments made toward a mortgage, and once enough equity has been placed in the property, homeowners can begin saving money on PMI payments. If you made extra payments to the principal, you might be eligible to get rid of PMI sooner. In this case, you would still need to notify your lender to have the payment removed.
Homebuyers can also get rid of PMI if the value of the property increases and they reach more than 20 percent equity in the home. There are two ways this can happen. First, property values could increase to where you have more equity in the home. Second, certain renovations could increase the value of the property, increasing your overall equity. In these cases, you will need to coordinate with your lender to determine the new property value.
Summary
Whether you’re a first-time homebuyer or an experienced real estate investor, it’s common to ask “What is PMI?” at some point or another. Understanding your options as a borrower is a crucial step as you prepare to buy your first house, and learning what PMI is in real estate can open the door to many potential prospects. Private mortgage insurance is a tool used to protect lenders when issuing home loans, and it can create an added monthly cost for the buyer. Depending on how you look at the situation, PMI can be both a disadvantage and an advantage to first-time homebuyers, mainly because the last thing anyone wants after purchasing a home is an additional monthly expense. But at the end of the day, it can also help buyers purchase real estate faster than they may be able to otherwise and begin making the required payments to lay their roots. Consider how this cost could influence your home buying timeline before deciding what is best for you.
Did you know how to remove PMI before reading this article? Share your thoughts in the comments below.
Sources
https://www.consumerfinance.gov/ask-cfpb/what-is-private-mortgage-insurance-en-122/
https://www.consumerfinance.gov/ask-cfpb/when-can-i-remove-private-mortgage-insurance-pmi-from-my-loan-en-202/
https://www.rocketmortgage.com/learn/pmi-insurance
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